Inflation continues to moderate, though stocks seeing pressure in August

ANTHONY SAGLIMBENE – CHIEF MARKET STRATEGIST, AMERIPRISE FINANCIAL

WEEKLY MARKET PERSPECTIVES — August 14, 2023

Disinflation trends across the economy appear to be taking root

In our view, the biggest takeaway for investors from last week’s inflation reports was that disinflation trends across the U.S. economy remained intact in July. The headline and core measures of the July Consumer Price Index increased by just +0.2% for the second straight month. That marked the smallest back-to-back gains in consumer prices in more than two years. On a year-over-year basis, headline CPI ticked up to +3.2% in July versus +3.0% in June, but core CPI ticked down to +4.7% last month from +4.8% the prior month.

On the producer side, inflation was marginally hotter in July compared to June, with services and goods prices increasing month-over-month. Nevertheless, the slightly higher producer price trends in July are unlikely to detract from the overall disinflation trends that appear to be taking root. Easing supply pressures, normalizing economic activity, and more predictable inventory control should help producers manage costs and help offset some of the pressures from higher energy prices and wages.

Bottom line: Disinflation trends continue to evolve and reduce the odds of higher prices becoming entrenched in the U.S. economy. For example, airline fares dropped 8.1% last month, for its fourth consecutive monthly decline. Used car prices also fell in July, while the feared upward pressures of energy prices weren’t as aggressive in July as in June. Overall, we believe the July CPI report kept the bull’s view in play, which is partly built around a thesis of “peak Fed hawkishness” and a dynamic that soon sees the Federal Reserve moving to the sidelines and ending rate hikes more permanently. According to the CME FedWatch Tool, there is a 90% chance the Federal Reserve will hold rates steady at its September meeting. By December, nearly 60% of the market currently sees the fed funds rate ending the year where it stands today. And finally, helping to add evidence that inflation expectations remain contained, a preliminary look at the latest Michigan Sentiment Survey finds respondents see inflation lower over the next one and five years compared to their views in July.

In other items that grabbed investors’ attention last week:

• The bond market, and to some extent the stock market (from a what does it mean for rates perspective), successfully absorbed $103 billion in new Treasury issuance.
• Moody’s lowered the credit rating of ten small/medium-sized banks on concerns of funding costs, lower profitability, and commercial real estate exposure.
• The White House announced an executive order addressing U.S. investments in certain national security technologies/products in “countries of concern” (i.e., see China). The U.S. Treasury now has the authority to regulate certain U.S. investments abroad in semiconductors, microelectronics, quantum information, and Artificial Intelligence.

Q2 earnings season winds down with 80%+ of companies beating expectations

On the earnings front, roughly 92% of S&P 500 companies have reported second quarter results. The Q2 earnings beat rate continues to run at 80% plus, above the five-year average of 77%. Positive takeaways on the corporate front include a still resilient consumer, continued strength across Big Tech secular drivers, normalizing activity levels, firm spending on travel/leisure, solid auto/aerospace trends, benign credit conditions, normalizing supply chains, and higher capex spending. Earnings themes that have been less bullish include softening pricing power, wage pressures, reduced hiring, softening travel trends (from the peak), lower stock buybacks, and concerns regarding increased regulation.

Importantly, earnings expectations for the third and fourth quarters didn’t change much through the Q2 reporting season. Given that we see the U.S. economy growing by +1.3% in Q3, +0.6% in Q4, and forecast full-year GDP of +1.7% this year, earnings growth could very well turn positive on a year-over-year basis in the second half. It's also worth mentioning that if our full-year 2023 GDP forecast is achieved, it will put economic growth for this year within the boundaries of the U.S. economy’s normalized, longer-term growth trend. As such, corporate profitability could turn higher in Q3 and Q4, as corporate profits and economic growth are closely correlated. And yes, we’ll state the obvious here: such an environment would likely be stock friendly.

This week, retailers will help close the Q2 earnings season, with The Home Depot (Tuesday), Target Corp. (Wednesday), The TJX Cos, Inc. (Wednesday), Walmart Inc. (Thursday), and Ross Stores, Inc. (Thursday) the key reports to watch.

Disinflationary themes may help ease pressure on stocks, but investors could see short-term resetting across the market

From a what does it mean for the market perspective, we believe disinflation themes and the growing possibility Fed policy is likely near the end of its tightening phase could help put a floor on any sustained pressure on stocks over the coming weeks and months. A recent San Francisco Federal Reserve paper noted that the pressure from shelter inflation (a large part of core CPI) could ease substantially over time. At the same time, recent Fed commentary suggests the Federal Reserve may be done raising rates. On Wednesday, investors will get a look at the July FOMC meeting minutes. Here, we believe the market will look for color on how policymakers view the overall level of rate restrictiveness, views on the lagging effects of past rate hikes on the economy, and if central bankers believe current policy is enough to bring inflation down over time.

For the broader market, the S&P 500 Index has walked back from sitting above 4,600, seen some resistance at crossing back above 4,500, and sits right on top of its 50-day moving average. Valuations based on this year’s earnings and technical conditions across the S&P 500 have also become stretched, in our view. Further, Information Technology is off 7.0% in August (roughly 27% of the S&P 500 by market capitalization), while nine of eleven S&P 500 sectors are down month-to-date. Yet, with the S&P 500 still well above its 100-day and 200-day moving averages, combined with weaker seasonality trends in August and September, investors shouldn’t be surprised if stocks see some consolidation or even modest declines at some point through year-end.

It's worth mentioning that the average intra-year decline for the S&P 500 over the last thirty years is roughly +15.0%. Yet, over that time frame, excluding this year, the Index has finished positively in twenty-three of the last twenty-nine years. March’s drawdown in the S&P 500 may indeed be the low point for this year, or investors may need to work through a period before year-end that presses that low point down. However, if the broader market does push lower over the near-to-intermediate-term, we suggest investors take the pressure in stride. History indicates that stocks tend to finish the year with gains after a strong first half of performance. While past performance does not guarantee future results, investors shouldn’t necessarily mistake regular periods of consolidation/downdrafts as a sign that something is broken or breaking in the market. Should fundamentals hold, we believe some investors could greet potential downdrafts in the stock market as an opportunity to reallocate excess cash to equities