@theMarket: Oil Prices Boost Inflation But Don't Deter Investors
Stocks did remarkably well this week considering the macroeconomic data. That could be signaling further upside soon for the financial markets.
The decline in the inflation rate over the past six months has been encouraging. However, the recent climb in oil and gasoline prices threatens to put a crimp in the trend of declining inflation.
As I have written many times before, oil is the fuel that powers the global economy. It is involved in every stage of production and as such, its price has an enormous influence on the rate of inflation. Thanks to production cuts by OPEC-plus over the last few months, the price of oil has risen from roughly $65 a barrel to over $90 a barrel.
It was inevitable that this recent strength in oil would begin to show up in the macroeconomic data. It did. This week, the Consumer Price Index (CPI) and the Producer Price Index (PPI) for last month came in higher than expected. The culprit in both cases was the higher price of oil.
Producer prices in the U.S. increased by 0.7 percent in August, which was the highest level since June of last year. Within the index, energy prices increased by 10.5 percent. The CPI also increased by 0.4 percent on the back of higher gasoline prices.
While that was bad news for inflation, the economic picture got a boost as retail sales jumped 0.6 percent. That was much higher than the estimate for a 0.2 percent gain. But much of that increase was due to higher gasoline prices. If you exclude auto and gas, sales increased by only 0.2 percent.
Jobless claims also came in lower than expected indicating that jobs are still plentiful in the overall economy.
From a global perspective, the U.S. remains the place to put your money and the U.S. dollar reflects that sentiment as the greenback continues to gather strength.
Next week (on Sept. 19-20), is the next Federal Open Market Committee meeting (FOMC), The markets are betting that the Fed will hold off on another interest rate hike. Despite the stronger August inflation data, the feeling is that the Fed will hold off and wait to see more data before deciding on a rate rise possibly in November.
The risk for stocks next week is if the FOMC decides to raise rates again. That would throw the markets a real curve ball and likely send markets back on their heels. I give that a low probability given that the Fed would have already marched out several officials to disabuse investors' expectations of a pause.
As I have been writing, I expect a bounce shortly. It could take the S&P 500 Index up 1-2 percent or so. I am looking for the high end of this range, given that a pause by the Fed should be received favorably by world markets. It could also bring some relief to overseas markets that have been suffering under the weight of the strong dollar.
@themarket: Markets in a Topping Process
Fed Chairman Jerome Powell indicated that he was "prepared to raise rates further" at the Jackson Hole Symposium this week. Investors who were hoping to hear a more dovish outlook were disappointed.
The market walked away with an understanding that interest rates had two paths forward. The best case was flat for a longer period, or higher if inflation persists. About last year's address, Powell said "The message is the same: It is the Fed's job to bring inflation down to our 2 percent goal, and we will do so."
Beyond Friday's event, it was a slow week with little volume and plenty of volatility. Second-quarter corporate earnings in the retail sector were lackluster for the most part with forward guidance indicating a slowing in retail spending on the margin.
On the economic front, data revealed further weakness in certain sectors, but the job market remained buoyant. The weakness in the U.S. Purchasing Managers Index (PMI) indicated that demand for new business in the services sector contracted. This followed a bigger-than-expected decline in Euro Zone PMIs as well as slowing growth in China. All this data indicates that inflation may continue to fall but most of the downward pressure could be due to a softening economic picture in Europe and China.
The most important event of the week, aside from Powell's comments, revolved around an individual company, Nvidia, the semiconductor giant. Nvidia is the world's leader in the manufacture of Artificial Intelligence (AI) microchips. It commands an 80 percent market share worldwide. Many Wall Street analysts believe we are just at the beginning of an enormous multi-year demand for AI chips that will benefit Nvidia enormously.
Following a blockbuster May earnings report that rocked Wall Street and sent the stock soaring up 200 percent this year, Thursday's second-quarter earnings announcement blew away what were already sky-high expectations. The company reported a 101 percent jump in sales from last year, while earnings were up 429 percent. They also guided higher revenues for the coming quarter that was $3.5 billion higher than the loftiest estimates.
However, sometimes there is a difference between a company's fortunes and what happens to its common stock. The stock price had been bid up relentlessly for weeks before the earnings results. The earnings did catapult the stock higher after the announcement in the pre-market hours by 7 percent.
It took most of the market higher with it and dragged the tech-heavy NASDAQ up over one percent. And then boom, both the stock and the market tumbled shortly after the opening.
In hindsight, (as often happens in trading) all the good news was already discounted in the stock price. There was nothing left to do but sell on the news and that is exactly what traders did. Be aware, however, that this price decline has nothing to do with the fundamental value of the company and its prospects.
As for the markets overall, the S&P 500 index did give me the bounce I was looking for. It gained 2 percent this week before reversing back down. I believe we are in a topping process in the markets, which should continue into the second week of September. After that, I expect a bigger move down.
@theMarket: Bond Yields Up, Stocks Down
The seasonal influence of what is normally a weaker August through September continued this week. All the averages have declined since the end of July and will continue to do so in the weeks ahead.
My expected pullback in the equity averages continued this week. So far in August, the S&P 500 Index is down 5 percent, the NASDAQ has fallen 7 percent-plus, while the Dow Jones industrials outperformed with a 2.4 percent decline. There are several reasons investors could point to in explaining the pullback, but for me the reasoning is simple.
All the markets were extended beyond reason after a great first half of the year. The prices of the Magnificent Seven group of stocks were the worst offenders. To me, they were begging for a stiff bout of profit-taking. Add that to a seasonally weak time of the year in the markets and it was not hard to predict a sell-off.
Fundamentally, there is also a reason for concern. For more than two months or so, I have been warning readers that the U.S. Treasury was going to auction more than a trillion dollars of bills and bonds. That would, in my opinion, pressure yields on Treasury bonds higher and that is exactly what has occurred.
The benchmark, U.S. 10-year Treasury bond was above 4.31 percent on Thursday, which was its highest yield since 2008. This threatens steeper borrowing costs. There is a heightened concern that if this trend continues it could whack the equity, debt, and housing markets. A lot of bond vigilantes were expecting yields to drop, not rise. Some of these traders have been forced to unwind their long positions on bonds, which is causing yields to rise even further.
China has also been a big concern this week. The world's second-largest economy has been rolling over for months. The legacy of a COVID zero-tolerance policy, harsh regulatory restrictions on the nation's largest companies, overbuilding in the Chinese property sector, and a plunging currency are some of the reasons for this situation. The fault largely lies with the policies of China's leadership, specifically President-for-life, Xi Jinping.
And while some of us may applaud China's economic comeuppance, the facts are that when China catches a cold, most of the rest of the world develops a bad flu, as do their stock markets. China's top three trading partners are the group of ASEAN nations, followed by Europe. The U.S. is in the number three spot. Slowing growth in China means slowing profits for a wide spectrum of countries and companies throughout the world and the U.S. is not immune to this development.
The Jackson Hole Economic Symposium will be held next week (Aug. 24-26). Fed Chairman Jerome Powell will be sharing his economic perception of the U.S. economy as well as the world. There is always the possibility that he could throw a curve ball that investors are not expecting. The bond market will be watching for any comments on interest rates and rising yields.
As I said last week, I am waiting for a short-term bounce-up in the markets, since we are getting close to my target of a 5-6 percent decline in the S&P 500. Right now, I am expecting yet another possible drop into mid-September if yields continue to climb higher.
If I am right and we do slide, how far could the decline take us? The 4,100-4,000 level on the S&P 500 Index is possible. If things really get unstrung a fall to 3,800 might happen but I am not really expecting that.
@theMarket: Big-Cap Tech Earnings Bolster Markets
Corporate earnings results for Google and Meta helped push the averages higher this week, while Microsoft results were somewhat disappointing. The net result was higher stock prices for many sectors of the markets.
The most interesting change that I perceived in the overall markets this week was the FOMC's lack of impact on financial markets. Over the past year, these monthly two-day Fed events were market-moving. Investors parsed every word of every sentence in the meeting notes and spent hours and even days interpreting every answer that Chair Jay Powell uttered in the Q&A session.
This week, the Fed raised Fed fund rates yet again to a 22-year high at 5.25 percent. They also insisted that there could be more hikes to come if the data warranted. Nothing changed in their hawkish policy stance and yet, the markets closed flat on the day. It appears investors were far more interested in the earnings results of Meta which were announced after the close than on what the Fed had to say.
Granted, the markets expected and had already discounted a rate raise and a continuation of the Fed's policies. They also believe that even another rate raise or two is not going to have much of an impact on the overall health of the economy and corporate earnings.
Lending strength to this argument was the latest data on the U.S. economy which grew at a faster-than-expected pace in the second quarter of 2023. Gross Domestic Product grew at an annualized pace of 2.4 percent, which was faster than the consensus forecasts of 1.8 percent.
Readers may recall that the first quarter was revised upward to a 2 percent growth rate. Both consumer spending and nonresidential fixed investment were the engines of growth behind the results. To put this in perspective, these results were achieved despite 11 hikes in interest rates over the last year. At the same time, this week's unemployment claims continued to fall, indicating that employment is still robust. In addition, the Fed's favorite inflation gauge, the Personal Consumption Expenditures Index (PCE) dropped last month to its lowest level since March 2021.
What does that mean for the financial markets? It means that the era of a Fed-driven stock market may be coming to an end.
In the future, barring any drastic change in the world economies such as a rebound in inflation, a severe global recession, or another geopolitical event, investors may begin to emphasize fundamentals over Fed policy. Things like economic prospects, future revenues, income, profits, and the like could take a front seat in determining the proper level of equities in general and individual stocks in particular.
One change overseas caught my attention. The Bank of Japan's (BOJ) monetary policy has been dovish for years, but that may be changing. The central bank loosened its yield curve control that has anchored the yield on their ten-year government bond (JGB) at 0 percent for some time. The BOJ is planning to start purchasing 10-year JGBs at 1 percent through fixed-rate operations. Although minor, the change may indicate that Japan may be reversing its interest rate policies just as other countries are cutting or slowing their rate raises. If so, this could have a far-reaching impact on U.S. interest rates (higher) and the dollar(lower).
The S&P 500 Index topped 4,600 this week, so we are getting closer to my 4,630 target. At this point, it would not surprise me to see a pullback in August of the 5-6 percent variety sometime in the next few weeks.
@theMarket: Slowing Inflation Inflates Stocks
It appears the Federal Reserve Bank's long battle against inflation is showing some progress. This week, two key inflation measures indicated inflation rose at its slowest pace since March 2021. Investors celebrated the news.
The Consumer Price Index (CPI) for June rose a mere 0.2 percent and only 3 percent over the prior year. Both measures were a bit better than economists were forecasting. If you strip out food and gas prices, the core CPI climbed 0.2 percent month over month and 4.8 percent over last year; again, slightly better than expectations. The Producer Price Index (PPI) also saw some encouraging news. June's wholesale prices followed the CPI data lower. PPI rose 0.1 percent, less than the consensus estimate of 0.2 percent
All week, in anticipation of these expected cooler inflation numbers, market bulls were buying stocks. That gamble has paid off. The U.S. dollar dropped on the news. Bond yields also gave up recent gains.
That set up the perfect environment to rise for those sectors that have an inverse relationship with declining dollars and yields. Commodities, basic materials, and precious metals exploded higher. In another interesting turnabout, the small-cap Russell 2000 Index outpaced NASDAQ and the S&P 500 Index for the week.
As for the Magnificent Seven stocks and Nasdaq in general, prices took a back seat for once. An explanation for exactly why that should have occurred lies with a decision by the management of the NASDAQ 100. Last Friday, Nasdaq announced that the index will undergo a Special Rebalance effective before the market opens on Monday, July 24.
The intent is to reduce the concentration of heavyweight companies that now account for nearly half the weighting of the index. Microsoft, Apple, Nvidia, Amazon, and Tesla combined, account for 43.8 percent weight in the index. As part of the rebalance, that number will come down to 38.5 percent.
For portfolio managers and investment funds that track the index, it will mean selling some of the shares of these overweighted companies and increasing their share of other companies in the index. Since the announcement, the Magnificent Seven stocks have been volatile as has the index overall.
There is some speculation that the S&P 500 Index could follow suit. That would have a much more serious impact on stock prices overall because of the importance of this benchmark index. Rebalancing the S&P 500, as I understand it, would occur when the aggregate of companies, with each having a weight greater than 4.8 percent, exceeds 50 percent of the total index.
As of today, only Apple and Microsoft exceed that 4.5 percent weight. In total, these two stocks plus Amazon, Nvidia, and Tesla have a combined market value of the S&P 500 index of 22.2 percent. Fortunately, we have a long way to go before a rebalancing of that index is in the offing.
Last week, I mentioned that although the markets were stretched, I was hoping for a little more upside in the averages. That is exactly what occurred with a 100-point (2 percent) gain in the S&P 500 Index. At this point, don't be surprised if a bout of profit-taking were to occur. I am not expecting anything serious, just a pause as the market once again catches its breath.
As for me, I will be on vacation next week so do not expect my usual columns. I will be back the following week, ready to go.