Are Markets Shaking Off Inflation Fears?

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Samantha Subin and Yun Li of CNBC report the S&P 500 posts best week since November, Nasdaq surges 2% Friday as Alphabet soars: 

Stocks jumped Friday, and the S&P 500 and Nasdaq Composite notched their best week since November as Big Tech names rallied on strong earnings and traders pored through fresh U.S. inflation data.

The broad market index advanced 1.02% to settle at 5,099.96. The tech-heavy Nasdaq climbed 2.03% to close at 15,927.90 and secure its best daily move since February. The Dow Jones Industrial Average rose 153.86 points, or 0.4%, to finish at 38,239.66.

The S&P and Nasdaq clinched their best week since November. The S&P popped 2.7% to snap a three-week losing streak, while the Nasdaq gained 4.2% for its first positive week in five. The Dow edged up 0.7%.

“We are finishing a volatile week on a strong note,” said Mona Mahajan, senior investment strategist at Edward Jones. “It’s nice to see some green on the screen. Clearly one of the drivers has been the stellar reports coming out of megacap technology.”

Stocks got a boost from robust results from artificial intelligence competitors Alphabet and Microsoft after the bell Thursday. Alphabet jumped more than 10% on better-than-expected first-quarter earnings and recorded its best day since July 2015. The company also authorized its first-ever dividend and a $70 billion buyback. Microsoft added nearly 2% as the software maker posted strong fiscal third-quarter results and showed an acceleration in cloud growth.

Both companies have impressed investors by not only investing in artificial intelligence, but also by showing results, Mahajan said. The prints also helped alleviate some fears on the back of Meta Platforms’ disappointing guidance earlier this week, she said.

Investors also parsed March’s core personal consumption expenditures reading following a spate of reports that suggested slowing growth and sticky inflation. The gauge, excluding food and energy, rose 2.8% from a year ago and came in ahead of the 2.7% expected by Dow Jones. Personal spending rose 0.8%, ahead of a 0.7% estimate.

Those moves helped Wall Street regain some of its footing after a down day. The blue-chip Dow slid 375 points Thursday after new U.S. economic data showed a sharp slowdown in growth and pointed to persistent inflation.

The busy earnings season continues next week, headlined by results from technology giants Apple and Amazon. The Federal Reserve’s next rate decision is due out Wednesday.

It was another volatile week in markets where inflation fears played a role on the bond market and yields dictated risk-taking behaviour:

Specifically, Thursday morning's US GDP report showed the economy is slowing and inflation is picking up:

U.S. economic growth was much weaker than expected to start the year, and prices rose at a faster pace, the Commerce Department reported Thursday.

Gross domestic product, a broad measure of goods and services produced in the January-through-March period, increased at a 1.6% annualized pace when adjusted for seasonality and inflation, according to the department’s Bureau of Economic Analysis.

Economists surveyed by Dow Jones had been looking for an increase of 2.4% following a 3.4% gain in the fourth quarter of 2023 and 4.9% in the previous period.

Consumer spending increased 2.5% in the period, down from a 3.3% gain in the fourth quarter and below the 3% Wall Street estimate. Fixed investment and government spending at the state and local level helped keep GDP positive on the quarter, while a decline in private inventory investment and an increase in imports subtracted. Net exports subtracted 0.86 percentage points from the growth rate while consumer spending contributed 1.68 percentage points.

There was some bad news on the inflation front as well.

The personal consumption expenditures price index, a key inflation variable for the Federal Reserve, rose at a 3.4% annualized pace for the quarter, its biggest gain in a year and up from 1.8% in the fourth quarter. Excluding food and energy, core PCE prices rose at a 3.7% rate, both well above the Fed’s 2% target. Central bank officials tend to focus on core inflation as a stronger indicator of long-term trends.

The price index for GDP, sometimes called the “chain-weighted” level, increased at a 3.1% rate, compared to the Dow Jones estimate for a 3% increase.

Markets slumped following the news, with futures tied to the Dow Jones Industrial Average off more than 400 points. Treasury yields moved higher, with the benchmark 10-year note most recently at 4.69%.

“This was a worst of both worlds report – slower than expected growth, higher than expected inflation,” said David Donabedian, chief investment officer of CIBC Private Wealth US. “We are not far from all rate cuts being backed out of investor expectations. It forces [Fed Chair Jerome] Powell into a hawkish tone for next week’s [Federal Open Market Committee] meeting.”

The report comes with markets on edge about the state of monetary policy and when the Federal Reserve will start cutting its benchmark interest rate. The federal funds rate, which sets what banks charge each other for overnight lending, is in a targeted range between 5.25% to 5.5%, the highest in some 23 years though the central bank has not hiked since July 2023.

Investors have had to adjust their view of when the Fed will start easing as inflation has remained elevated. The view as expressed through futures trading is that rate reductions will begin in September, with the Fed likely to cut just one or two times this year. Futures pricing also shifted after the GDP release, with traders now pointing to just one cut in 2024, according to CME Group calculations.

“The economy will likely decelerate further in the following quarters as consumers are likely near the end of their spending splurge,” said Jeffrey Roach, chief economist at LPL Financial. “Savings rates are falling as sticky inflation puts greater pressure on the consumer. We should expect inflation will ease throughout this year as aggregate demand slows, although the path to the Fed’s 2% target still looks a long ways off.”

Consumers generally have kept up with inflation since it began spiking, though rising inflation has eaten into pay increases. The personal savings rate decelerated in the first quarter to 3.6% from 4% in the fourth quarter. Income adjusted for taxes and inflation rose 1.1% for the period, down from 2%.

Spending patterns also shifted in the quarter. Spending on goods declined 0.4%, in large part to a 1.2% slide in bigger-ticket purchases for long-lasting items classified as durable goods. Services spending increased 4%, its highest quarterly level since the third quarter of 2021.

A buoyant labor market has helped underpin the economy. The Labor Department reported Thursday that initial jobless claims totaled 207,000 for the week of April 20, down 5,000 and below the 215,000 estimate.

In a possible positive sign for the housing market, residential investment surged 13.9%, its largest increase since the fourth quarter of 2020.

Thursday’s release was the first of three tabulations the BEA does for GDP. First-quarter readings can be subject to substantial revisions — in 2023, the initial Q1 reading was an increase of just 1.1%, which ultimately was taken up to 2.2%.

Now, typically when the economy is slowing and inflation persists, it means stagflation lies ahead, ie. low growth and high inflation.

This morning's PCE inflation, the Fed's favourite measure, clearly shows that inflation remains sticky:

In other words, all the data so far is showing inflation isn’t going away, and is making things tough on the Fed:

The stubborn inflation data raised several ominous specters, namely that the Fed may have to keep rates elevated for longer than it or financial markets would like, threatening the hoped-for soft economic landing.

There’s an even more chilling threat that should inflation persist central bankers may have to not only consider holding rates where they are but also contemplate future hikes.

“For now, it means the Fed’s not going to be cutting, and if [inflation] doesn’t come down, the Fed’s either going to have to hike at some point or keep rates higher for longer,” said LaVorgna, who was chief economist for the National Economic Council under former President Donald Trump. “Does that ultimately give us the hard landing?”

The inflation problem in the U.S. today first emerged in 2022, and had multiple sources.

At the beginning of the flare-up, the issues came largely from supply chain disruptions that Fed officials thought would go away once shippers and manufacturers had the chance to catch up as pandemic restrictions eased.

But even with the Covid economic crisis well in the rearview mirror, Congress and the Biden administration continue to spend lavishly, with the budget deficit at 6.2% of GDP at the end of 2023. That’s the highest outside of the Covid years since 2012 and a level generally associated with economic downturns, not expansions.

[...] 

Thus far, the economy has managed to avoid broader damage from the inflation problem, though there are some notable cracks.

Credit delinquencies have hit their highest level in a decade, and there’s a growing unease on Wall Street that there’s more volatility to come.

Inflation expectations also are on the rise, with the closely watched University of Michigan consumer sentiment survey showing one- and five-year inflation expectations respectively at annual rates of 3.2% and 3%, their highest since November 2023.

No less a source than JPMorgan Chase CEO Jamie Dimon this week vacillated from calling the U.S. economic boom “unbelievable” on Wednesday to a day letter telling The Wall Street Journal that he’s worried all the government spending is creating inflation that is more intractable than what is currently appreciated.

“That’s driving a lot of this growth, and that will have other consequences possibly down the road called inflation, which may not go away like people expect,” Dimon said. “So I look at the range of possible outcomes. You can have that soft landing. I’m a little more worried that it may not be so soft and inflation may not go quite the way people expect.”

Dimon estimated that markets are pricing in the odds of a soft landing at 70%.

“I think it’s half that,” he said.

Now, if inflation pressures persist, why didn't the 10-year US Treasury yield break above the 5% level reached in October?

Part of the reason, I believe, is technical meaning jut like stock prices, yields don't go up and down in a  straight line, so I expected a cooling off period.

But the other part is some people strongly feel inflation has peaked here:

Clearly, if inflation is subsiding here, bonds are a screaming buy but the risk is inflation persists and a wage spiral develops or worse still, we get more geopolitical tensions and oil prices surge.

Admittedly, it's the wage spiral that worries me more as I hear a lot of of anecdotal evidence from the US that workers are asking for and getting wage increases.

They need to pay for housing, food, gas, insurance and these costs are adding up, so either they ask for more or leave for a better job and with the labour market still tight, they can do so.

However, as the economy slows, you expect unemployment to go up and wages to stagnate.

We shall see but this is the most important trend to watch in the second half of the year and there are some macro things out there that concern me:

The yen imploding means higher inflation in Japan which can then translate into higher yields thee and throughout the world. Something definitely to watch going forward.

As far as stocks, they moved with yields this week, as the 10-year spiked to 4.74% on Thursday morning following the GDP report, stocks sold off hard and Meta's less than stellar earnings didn't help.

Then on Thursday after the bell, Google and Microsoft reported great numbers and it was RISK ON Friday.

And Nvidia, aka hedge funds' favourite beat beast, it was in beast mode pretty much all week after dipping 10% last Friday:

Remember what I keep telling you, these large cap megacap tech stocks are so systemically important, they don't fall or rise in a straight line.

If rates are coming down, this will help the Mag 7 stocks but if inflation persists and rates back up again, they will feel more pain.

The same goes for biotechs, a sector I trade and know all too well, they give me ample warning signs about risk-taking behaviour.

And if a recession strikes and the Fed cuts rates, it's game over for stocks, pretty much all stocks.


Lastly, it is worth noting the S&P’s Risk-On momentum is getting an added boost from rebounding profits:

With the quarterly reporting season roughly half over, US corporate earnings have largely lived up to Wall Street’s optimistic expectations even as macroeconomic headwinds linger.

Of the roughly 230 S&P 500 Index firms that have reported, some 81% have delivered upside surprises, data compiled by Bloomberg Intelligence shows. If the figure holds, it would handily best the 10-year average of roughly 75%. Favorable results from Wall Street darlings like Alphabet Inc. and Microsoft Corp. lifted sentiment, even as heavyweight Meta Platforms Inc. failed to shine.

In some ways, this earnings cycle resembles the last one — with the chatter around artificial intelligence and the focus on sticky inflation and corporate margins. Yet the backdrop has morphed. Geopolitical tension and fading hopes for Federal Reserve interest-rate cuts have helped drive the S&P 500 down almost 3% this month. In the face of that, Corporate America has offered crucial support for the market.

“At a time where expectations for corporate earnings were lofty, and we’ve already absorbed the fact the Federal Reserve isn’t going to cut seven times — those two things together have renewed debate over how bullish we should be,” said Scott Helfstein, head of investment strategy at Global X. “But in the end, that’s where I get back to that headline: corporate profitability has leveled up.”

Here’s are five takeaways from earnings season so far:

Stockpickers’ Time

Traders, by and large, expect stocks will move out of sync with one another, bringing opportunities to pick winners and losers. While a measure of implied correlations among the 50 largest S&P 500 firms has risen in recent months, the bounce is from a historically low level.

Some of the divergence can be chalked up to the relative performance of various sectors. For example, while analysts expect earnings-per-share growth in communication services and information technology, they project contractions for energy and materials, data compiled by Bloomberg Intelligence shows.

“When the correlations are high, it’s very difficult for active management,” said Don Nesbitt, senior portfolio manager at ZCM. “A low correlation is what you want for a stockpicker.”

Down Days

Corporate results have usually served as a cornerstone of the market’s advance. This century, the S&P 500 has gained during two-thirds of earnings seasons, with losses during that time almost always happening for a clear reason, like the escalation of trade tension with China, data compiled by Bloomberg show.

This cycle is on track to defy the typical pattern: The S&P 500 is down 1.9% since the morning of April 11, when JPMorgan Chase & Co. and other big banks kicked off earnings.

Tech Swings

Investors have underestimated how much Big Tech shares would move after their results. Of the four Magnificent Seven firms that have reported — Tesla Inc., Meta, Microsoft and Alphabet — three have posted next-day moves that surpassed what options implied.

Before the reports, traders were bracing for somewhat subdued swings relative to what the shares did in past seasons. As Citigroup Inc.’s Stuart Kaiser sees it, bullish outlooks for the AI champions may have led to lower implied moves. But the big leaps thus far could stoke expectations for more notable swings ahead.

“There’s a chance that those later reporters have a lower likelihood of beating the implied move just because people have had a chance to reassess,” Kaiser said.

Margin Recovery

Consumer prices have grown more quickly than producer prices in recent quarters. That’s helped support a recovery in S&P 500 margins amid corporate cost-cutting that’s also helped drive profits higher.

Margins are a key gauge of profitability that historically offers a signal on where a stock is headed. Wall Street sees S&P 500 margins for the first quarter at about 14%, up from below 12% in early 2020, with forecasts for improvement in the coming quarters, data compiled by BI show.


That said, rising producer prices may erode the progress on margins, says Gina Martin Adams, chief equity strategist at BI.

“Keep a close eye on margins,” she said. “We saw signs of stabilization in the past year, but now rising commodity prices are eroding margin improvement for some sectors, which isn’t something that’s been embedded in analysts’ expectations.”

Bank Questions

The big lenders delivered somewhat mixed results. JPMorgan and Wells Fargo & Co. kept guidance conservative, while Goldman Sachs Group Inc. rallied the day of its release.

Over the coming months, loan growth is expected to remain muted. For this reporting period, analysts expect banks’ earnings per share to contract roughly 6% year-over-year, data compiled by BI show.

But RBC’s Gerard Cassidy, in a note, said sentiment remains “constructive” on the group, and says some of the worst pressures are behind it. Traders appear to agree, as demand to hedge against losses in shares of large and regional banks has declined lately.

Alright, let me end it there, it's Friday, time to relax and enjoy the weekend.

Below, Cantor's Eric Johnson, Payne Capital's Courtney Garcia and Invesco's Brian Levitt, join 'Closing Bell' to discuss markets, PCE, potential for rate cuts, and the state of the consumer.

Next, John Kolovos, Macro Risk Advisors chief technical market strategist, joins 'Closing Bell' to discuss his market outlook and what he's seeing in the technicals.

Third, Vahan Janjigian, CIO of Greenwich Wealth Management, Marc Giannoni, chief U.S. economist at Barclays, and CNBC's Steve Liesman join 'The Exchange' to discuss the potential for rate cuts, outlooks on economic data, and more.

Fourth, Jim Bianco, Bianco Research President, joins 'Fast Money' to talk the Yen hitting a 34-year low against the dollar and what it signals to the bond market.

Lastly, JPMorgan Chase CEO Jamie Dimon says the U.S. consumer is in good shape right now, but a huge fiscal deficit and geopolitical challenges like the Israel-Hamas War and Russia-Ukraine War make him cautious about the future.

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