Inflation Uncertainty Weighing Down Markets?

Maggie Fitzgerald of CNBC reports the S&P 500 falls Friday, notches second straight week of losses in September slump:

Stocks dipped on Friday as investors remain cautious due to a resurgent Covid virus, a Federal Reserve meeting next week and a historical tendency for September to be a weak month for equities.

The Dow Jones Industrial Average lost 166.44 points or 0.5% to close at 34,584.88, dragged down by a nearly 2.9% drop in Dow Inc. The S&P 500 shed 0.9% to 4,432.99 and the Nasdaq Composite lost 0.9% to close at 15,043.97.

Mega-cap technology stocks were mostly in the red, with social media giant Facebook dropping 2.2% and Alphabet falling just shy of 2%. Apple lost 1.8%, and Microsoft slipped 1.7%.

The Food and Drug Administration advisory committee on Friday rejected a plan to administer booster shots of Pfizer and BioNTech’s Covid-19 vaccine to the general public. Pfizer fell 1.3% and BioNTech dropped 3.6%. Moderna lost 2.4%.

History is not on the market’s side with the S&P 500 averaging a 0.4% decline for September, the worst of any month, according to the Stock Trader’s Almanac. Friday in particular begins a historically weak period for stocks as those September losses typically come in the back half of the month.

Some of the volatility that comes during September is often surrounding so-called quadruple witching, which occurred at the close Friday. This is the expiration of stock index futures, stock index options, stock options, and single-stock futures.

“We expect volatility to increase over the next month driven by a seasonal pickup in investor uncertainty, continued virus uncertainty, and significant monetary and fiscal policy catalysts,” wrote John Marshall, head of derivatives research for Goldman Sachs, in a note Friday. Marshall cited data showing S&P 500 volatility typically increased by 27% from August to October.

Still, stocks closed on Friday with losses for the week. The Dow slipped less than 0.1% this week, for its third straight week of declines. The Dow has not had a 3-week losing streak since September 2020. The S&P 500 fell nearly 0.6% since Monday for its second straight week of losses. The Nasdaq Composite dropped close to 0.5% this week.

For the month, stocks are also trading in negative territory. The Dow is down about 2.2% in September. The S&P 500 is off by nearly 2% this month but still just 2.5% from its all-time high. The Nasdaq has lost 1.4% this month.

The Federal Reserve meets for two days next week and on Wednesday is expected to give further clues as to when it may start to slow its $120 billion in monthly bond purchases that have supported the recovery, but also perhaps aided in a jump in inflation.

The U.S. 10-year Treasury hopped 4 basis points to nearly 1.37% on Friday.

Fed Chief Jerome Powell has said the so-called tapering could occur this year, but investors are waiting for more specifics. Some investors fear a decline in asset prices as the central bank begins to take away its easy policies.

Shares of Invesco jumped about 5.5% after the Wall Street Journal reported the money manager is in talks to combine with State Street’s asset-management business. Invesco manages about $1.5 trillion.

Stephen Culp of Reuters also reports on how Wall Street ends rollercoaster week sharply lower:

U.S. stocks closed sharply lower in a broad sell-off on Friday, ending a week buffeted by strong economic data, corporate tax hike worries, the Delta COVID variant, and possible shifts in the U.S. Federal Reserve's timeline for tapering asset purchases.

All three major U.S. stock indexes lost ground, with the Nasdaq Composite Index suffering the biggest decline as rising U.S. Treasury yields pressured market-leading growth stocks.

They also posted weekly losses, with the S&P index suffering its biggest two-week drop since February.

"The market is struggling with prospects for tighter fiscal policy due to tax increases, and tighter monetary policy due to Fed tapering," said David Carter, chief investment officer at Lenox Wealth Advisors in New York.

"Equity markets also a little softer due to today's weak Consumer Sentiment data," Carter added. "It's triggering concerns that the Delta variant could slow economic growth."

A potential hike in corporate taxes could eat into earnings also weigh on markets, with leading Democrats seeking to raise the top tax rate on corporations to 26.5% from the current 21% .

While consumer sentiment steadied this month it remains depressed, according to a University of Michigan report, as Americans postpone purchases while inflation remains high.

Inflation is likely to be a major issue next week, when the Federal Open Markets Committee holds its two-day monetary policy meeting. Market participants will be watching closely for changes in nuance which could signal a shift in the Fed's tapering timeline.

"It has been a week of mixed economic data and we are focused clearly on what will come out of the Fed meeting next week," said Bill Northey, senior investment director at U.S. Bank Wealth Management in Helena, Montana.

Unofficially, the Dow Jones Industrial Average fell 168.15 points, or 0.48%, to 34,583.17, the S&P 500 lost 41.06 points, or 0.92%, to 4,432.69 and the Nasdaq Composite dropped 137.96 points, or 0.91%, to 15,043.97.

The S&P 500 ended the session below its 50-day moving average, which in recent history has proven a rather sturdy support level.

Of the 11 major sectors in the S&P 500, materials and technology shares had the biggest percentage drops.

Shares of COVID vaccine manufacturers Pfizer Inc (PFE) and Moderna Inc (MRNA) fell as U.S. health officials moved the debate over booster doses to a panel of independent experts. 

U.S. Steel Corp (X) dropped after it unveiled a $3 billion mill investment plan.

Robinhood Markets Inc (HOOD) advanced following Cathie Wood's ARK Invest's purchase of $14.7 million worth of shares in the trading platform.

Alright, it wasn't a particularly great week for stocks, weakness persists, it's September, a lot of people are nervously awaiting what the Fed will say this upcoming week.

A lot of technical analysts are pointing to the fact that the S&P 500 closed below its 50-day moving average today but read Jonathan Krinsky's tweet below before jumping to any conclusions:

When every dip is bought hard by institutional and retail investors knowing the Fed has their back, it explains why we haven't seen a more meaningful selloff. 

The big news this week was US inflation data which cooled slightly in August with the headline rate falling to 5.3% while core rate that strips out volatile items was even lower at 4%. 

But a debate still lingers on whether inflation is transitory or more sticky:

Economists, too, have been trumpeting caution about high inflation, arguing that the large yearly numbers being seen are mostly a factor of COVID artificially dragging down baseline prices a year ago, and ongoing supply chain issues causing them to look artificially high now.

The economic term for short-term gyrations such as that is "transitory" — meaning they are just passing through, and may not last.

Economist Jennifer Lee with Bank of Montreal says the August numbers are high by any metric, but they do seem to suggest that some of the gains are running out of steam.

"Is this the end of the big monthly increases? I wouldn't say that, as demand is still strong and could pick up further with wages rising," she said. She noted that used car prices have been one of the biggest contributors to high inflation in recent months, but prices for them fell by 1.5 per cent in August — the first drop since February.

"The 'is it transitory' debate is far from over, but at least this more moderate gain in consumer prices will give the Fed some breathing room next week," in terms of setting its benchmark interest rate, Lee said. "But not for long."

Leslie Preston with TD Bank noted that "travel-related" prices, had been a big factor in driving inflation up in the spring, fell in August. Prices for shelter and medical supplies, meanwhile, heated up. "Once the post-pandemic price reversals are no longer a weight on inflation, these more persistent categories are likely to help keep inflation above target," she said.

On shelter inflation, professor Campbell Harvey of Duke University and partner at Research Affiliates, posted something on Linkedin that caught my attention:

Consider the CPI headlines “Inflation Eased in August” and “Welcome Sign to the White House.” The year-over-year (YoY) rate fell from 5.4% to 5.3%, but something weird is going on, which I have mentioned before. Shelter is 32.6% of the CPI and the YoY CPI shelter inflation rate is only 2.8%. Both housing prices and rents have increased much more. The Case-Shiller 20-City Composite Home Price Index is up 19.1% YoY. median rental prices are up about 11% YoY and 13.8% over the January-August period. Higher shelter prices do not seem temporary to me. The current gap between officially reported inflation and reality shows a remarkable disconnect and will likely drive increased inflation in the future. Policymakers continue to talk down expectations with excuses like “temporary” and “base effects.” They likely fear self-fulfilling expectations (when people expect higher inflation they demand higher wages and set product prices higher). We can learn more by looking at the data directly.

If the inflation story is indeed a lot stickier than the headline number suggests because shelter CPI will rise significantly to catch up to actual housing and rental data, then the Fed will taper sooner rather than later.

Cam seems to suggest inflation is far from transitory and that if it persists, workers will demand higher wages.

This is where I am unconvinced. We aren't in the 1970s where labor unions had clout to demand higher wages. It's a lot tougher nowadays for workers to demand anything, let alone higher wages.

But if wages do indeed creep up -- and we are seeing some modest evidence of this at companies like Amazon -- then it will impact margins and ultimately profits. And that's going to impact stocks in a negative way unless productivity increases to keep margins elevated.

There's a lot to ponder here. If investors get this inflation story wrong (either way), it can cost them dearly. 

However, you can't take a US-centric approach when looking at inflation. 

You really need to look at what is going on outside the US too.

And there, I'd say deflationary headwinds are springing up.

In his latest weekly market wrap-up, Rolling Uncertainties, Martin Roberge of Canaccord Genuity writes:

Our focus this week is on China’s Evergrande and the possible outcomes from here. Some analysis is required given that the bulk of EM underperformance YTD can be related to the collapse in the share price of this property developer (see our Chart of the Week). As a general view, it would be unlikely that the central government allows for a complete bankruptcy of Evergrande, given the contagion risk in credit markets, which could create another Lehman Brothers-type systemic event. A second scenario would be a bazooka response, with governmental authorities guaranteeing Evergrande’s debt. This would be similar to the US auto industry bailout by the government in 2009. But before this weapon is used, the Chinese economy would likely endure more pain, which means a potential V-shaped bottom in Chinese equities. A key question mark, however, is timing. A third scenario, which is more likely in our view, is a partial bankruptcy with Evergrande selling projects from its portfolios to other property developers and some form of debt rollover being granted. Since this a gradual process which might not prevent credit markets seizing up, the PBoC would inject more liquidity into the economy to combat contagion. This tug-of-war could translate into a W-shaped bottoming phase for Chinese equities and investors sticking to EMCX-US over EEM-US. For now, financial markets seem to embrace this third scenario, as credit markets outside China are not showing any signs of rising financial stress.

I honestly don't now what to make of the collapse of China’s Evergrande but if it isn't handled properly, contagion risks will rise and along with them, the risk of another deflationary episode.

Alright, let me wrap it up there, wish everyone a great weekend.

Below, Keith Lerner, Truist Advisory Services chief market strategist, Elyse Ausenbaugh of JPMorgan Securities and Peter Cecchini of Axonic Capital react to the latest consumer price index report and talk about what it means for tapering by the Federal Reserve. They are on "Bloomberg The Open."