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Inflation continues to keep investors on the defense




Last week, the S&P 500® Index fell by 2.1%, while the NASDAQ Composite closed lower by 2.6%. The trading week was cut short in observance of the Good Friday holiday, but that didn’t stop both indexes from finishing their second consecutive week in the red. The Dow Jones Industrials Average ended the week down 0.8%, sliding lower for the third straight week. Needless to say, the second quarter is off to a rough start for stocks. 

Frankly, April seems to be offering more of the same volatility investors grew accustomed to seeing in Q1. The S&P 500 is on a nine-year winning streak in April. Over the last twenty years, the Index has posted its best monthly average performance in April. However, so far, the month has brought more showers than flowers. The S&P 500 is off roughly 3.0% month-to-date, while the NASDAQ Composite has shed another 6.0%. Consumer Staples, Energy, Utilities, and Healthcare are outperforming this month, while Info Tech and Communication Services continue to come under pressure. It remains to be seen if the earnings season can bring about better trends in the back half of the month. Notably, stock volatility has remained elevated, given inflation, interest rate dynamics and uncertainties associated with Q2 company outlooks.

As we noted last week, the first quarter earnings season is here and will kick into full swing, with 67 S&P 500 companies reporting over the next five trading days. As a result, corporate profits and accompanying outlooks will likely take center stage over the next few weeks, with investors paying particularly close attention to profit margins and demand outlooks. In addition, while moves across interest rates and other macro items should influence stocks over the near term, corporate updates are likely to drive prices through the rest of this month.  

Investors take earnings in stride as companies report mixed results and outlooks 

With about 7% of first quarter S&P 500 results complete, the overall tone and start to the earnings season has been mostly favorable. Last week, earnings growth came in a little stronger than expected in aggregate, though earnings per share and sales beat rates are down versus historical averages. Importantly, net profit margins are tracking near expectations, with some analysts seeing the first quarter marking the low point in margins this year, given likely peak inflation pressures. 

However, last week's barrage of bank earnings provided a mixed bag of results and outlooks. Global banks gave a downbeat assessment of their exposure to Russia and increased reserves, with some booking Q1 losses on their exposure. At the same time, more domestically exposed financial institutions highlighted strong U.S. consumer trends, improving loan growth, and better than expected trading revenue in the first quarter. 

Bottom line: Investor reactions to this earnings season are likely a case-by-case situation, with broader industry trends less dominant in directing stock traffic through the earnings season. Unfortunately, this could keep market volatility elevated over the near term. And though low Q1 profit expectations offer an opportunity for companies to outperform, there is an increased risk company outlooks won’t be as rosy as analysts have penciled in for Q2 and beyond. This week, investors will hear updates from a number of banks, airlines, industrial conglomerates, communication providers, and several consumer-facing product and service companies. In particular, rail/trucking companies will offer some insight into supply chain dynamics, while companies leveraged to commodity prices are also on the earnings docket over the coming days.

Could consumers be seeing the peak for inflation?   

Turning back to last week, inflation reports contributed to keeping investors on the defensive. Headline March consumer price inflation (CPI) rose +8.5% year-over-year, or the highest level since 1981. Headline producer price inflation (PPI) rose +11.2% last month, its highest level since the report's introduction in 2010. However, month-over-month core CPI (ex. food and energy) rose just +0.3% in March, lower than the +0.5% pace seen in February. Notably, roughly half of the March headline CPI increase resulted from higher energy prices, up +11% m/m and +32% y/y.

Importantly, the inflation updates confirmed that price pressures have not become unanchored and that record-high prices in March may mark the peak for this cycle. As a result, we believe stocks could eventually see some tailwinds from the idea that aggressive rate actions by the Federal Reserve forecast in the front half of the year won’t need to be as aggressive in the back half of the year. But investors should still expect the Fed to move its Fed Funds target rate closer to neutral (neither supportive nor restrictive on economic growth) over the year, which could end above 2.0%. While we believe the economy can handle such a level, it may take time for the stock market to adjust until investors build comfort around the pace of future rate hikes. 

A slightly weaker-than-expected March retail sales report and a stronger-than-forecast preliminary look at April University of Michigan consumer sentiment last week showed U.S. consumers are under pressure from rising inflation, but are still confident about wages and the overall labor market.   

March home data will be the economic highlight for the week 

In addition to a heavy earnings calendar, March home data will be the economic highlight of the week. Housing starts, building permits, and existing home sales should provide a window into how consumers are reacting to higher mortgage rates and elevated home prices. On Friday, investors will receive a preliminary look at April PMI data. FactSet estimates suggest April's activity for manufacturing and services continued to expand, which has remained resilient over recent months, indicating that economic activity has not faltered in the face of inflation pressures.

Lastly, the backup in rates and the price of a barrel of oil continue to create reactionary responses in the stock market, which looks to discount their effects on growth. The 10-year U.S. Treasury yield finished last week above 2.8%, while West Texas Intermediate (WTI) oil closed near $107 per barrel. Simply, higher rates and more expensive crude can sap spending and reduce growth over time. Look for stocks to react to movements in each under the surface this week and as more companies begin to report their Q1 results.

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A 10-year Treasury note is a debt obligation issued by the United States government that matures in 10 years. The 10-year yield is typically used as a proxy for mortgage rates, and other measures.

West Texas Intermediate (WTI) is a grade of crude oil commonly used as a benchmark for oil prices. WTI is a light grade with low density and sulfur content

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The Michigan Consumer Sentiment Index (MCSI) is a monthly survey of consumer confidence levels in the United States. It is a statistical measurement of the overall health of the economy as determined by consumer opinion. It takes into account people's feelings toward their current financial health, the health of the economy in the short-term, and the prospects for longer-term economic growth, and is widely considered to be a useful economic indicator.

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