Stocks looking for traction amid persistent inflation and tighter rate policy
ANTHONY SAGLIMBENE – CHIEF MARKET STRATEGIST, AMERIPRISE FINANCIAL
WEEKLY MARKETS COMMENTARY — September 19, 2022
The S&P 500® Index closed below the psychologically important 3,900 level last week for the first time since mid-July, finishing at 3,873. Note: On June 17, the Index touched 3,636, its intraday low for the year. The S&P 500 lost 4.8% last week, marking its fourth week lower out of five. By last Friday's close, the S&P 500 had lost nearly 10% since its recent peak on August 12, had declined 19.6% from its January 4 high, and sat lower by 18.7% for the year.
Traders quickly moved into a risk-off position following a hotter-than-expected August Consumer Price Inflation (CPI) report on Tuesday, which precipitated the S&P 500's worst trading session since June 2020. In our view, you can boil the market's turbulence last week down to one simple statement: Given lingering inflation pressures across the U.S. economy, the terminal rate at which the Federal Reserve will finally stop raising interest rates is likely higher than most assumed before the August CPI report, and that terminal rate may linger at higher levels for longer. Simply put, the headwinds to growth and profits often created by higher interest rates appeared to again take a more prominent role in shaping stock trading last week. But, of course, that's the center-stage theme investors have been grappling with all year, so what's really changed?
Headline August CPI rose +8.3% year-over-year, hotter than the +8.1% expected but cooler than the +8.5% print in July. Core CPI also came in hotter than expected last month at +6.3% year-over-year and, notably, was hotter on a month-over-month basis versus estimates and July levels. Further, shelter prices sit at their highest level since January 1991, food prices remain at their highest levels since May 1979, and electricity prices hit their highest mark since August 1981. Notably, Producer Price Inflation (PPI) in August continued to moderate at the wholesale level versus July but came in hotter than expected on a headline and core basis.
Bottom line: The market is quickly coming around to the idea that inflation is likely to be more persistent and stickier than assumed in the summer. And while prices are moderating in certain areas, such as gasoline and other commodities, the Federal Reserve has more wood to chop to cool demand and curb price growth. Yet, in a sign that quickly tightening monetary policies could already be dampening activity, FedEx warned last week that earnings are tracking much weaker than expected just a few months ago. However, the more concerning point in that item is that the company highlighted softening global demand as the culprit, not increasing prices or supply chain issues. Unfortunately, the FedEx profit warning late in the week just added to investors' already sour mood.
Consumers expect inflation will continue to moderate in the quarters ahead; nevertheless, the path of least resistance for stocks is lower over recent weeks
Interestingly, a preliminary look at September Michigan consumer sentiment showed one-year inflation expectations coming down to +4.6% from +4.8% in August — the lowest level since September 2021. In addition, five-year inflation expectations in the survey dropped to +2.8% from +2.9%. We believe moderating inflation pressures in the CPI print last month, combined with consumers' expectations that inflation will continue to moderate in the quarters ahead, is a positive sign higher prices have not yet become entrenched in sentiment. This is likely to be a critical dynamic that the Fed continues to monitor closely over the coming months.
On the week, the NASDAQ Composite dropped 5.5%, its worst five-day stretch since June. Growth again underperformed Value, though both factors were lower, while the Dow Jones Industrials Average lost 4.1%. The Russell 2000 Index finished the week lower by 4.5%. Treasury prices were also weaker across the curve as rates climbed higher. The 2-year/10-year U.S. Treasury spread continued to invert, touching its lowest point since 2000, with the 2-year yield at one point during the week rising to 3.90%. By the end of the week, however, the 2-year U.S. Treasury yield settled at 3.85%, while the 10-year yield finished at 3.45%. The U.S. dollar closed the week higher by +0.6%, Gold fell 3.0%, and West Texas Intermediate (WTI) logged its third consecutive week lower, dropping 1.9% to finish at $85.27 per barrel.
The path of least resistance has undoubtedly turned lower over recent weeks, with still hot inflation prints, defensive positioning among professional money managers, tighter financial conditions, and growth forecasts moving lower. The World Bank recently warned that the global economy might face a recession triggered by aggressive central bank tightening that may not be sufficient to combat inflation. At the same time, August U.S. retail sales came in stronger than expected, though sales in the control group were weaker than forecast. During the week, a potentially crippling U.S. rail strike was averted, regional Fed manufacturing gauges showed mixed results, and weekly initial jobless claims and continuing claims were down week-over-week. In the U.K., sterling hit its lowest level versus the U.S. dollar since 1985 and its weakest level versus the euro in 17 months. Finally, on the sidelines of the Shanghai Cooperation Organization Summit last week, China President Xi Jinping and Russian President Vladimir Putin held a meeting to discuss their respective core interests and support for one another.
This week all eyes turn to the Fed and housing data
Looking ahead to this week, the U.S. calendar is all about the Federal Reserve and housing data. 75 or 100 basis points? That's the central question the market will attempt to further discount the answer into stock prices this week and heading into the Federal Reserve's two-day September policy meeting starting on Tuesday. On Wednesday, the Federal Reserve will deliver its decision on rate policy. According to the CME FedWatch Tool, the market currently places an 80% probability the Fed will lift its fed funds rate by 75 basis points this week and a 20% chance the central bank will raise rates by 100 basis points. A 75 basis point rate hike would mark the third consecutive move of that magnitude and take the target rate to 3.0% - 3.25%. Some Fed watchers see a potential 100 basis point move this week as a recognition that the central bank is behind the inflation curve and could increase scrutiny on its policy moving forward. This could also further disrupt stock prices, in our view. At the same time, a 100 basis point move could exacerbate concerns that the Fed is steering the U.S. economy into a recession without knowing the full effects of its previous rate hikes. In our view, a 75 basis point move higher continues to be the most likely path on Wednesday.
On the housing front this week, the National Association of Home Builders Housing Market Index is expected to come in near the August reading. However, the housing index has fallen lower every month this year and breached below the expansion level of 50 last month for the first time since May 2020. August building permits, housing starts, and existing home sales also color the week on the housing front. According to the St. Louis Federal Reserve, the average 30-year fixed mortgage rate currently stands at roughly 6.0% today, more than double the rate one year ago. Unsurprisingly, housing interest among consumers has taken a notable shift downward in 2022. On Friday, S&P Global will release preliminary looks at September manufacturing and services activity in the U.S. FactSet estimates call for manufacturing activity to remain modestly above the 50 threshold, marking expansion, while services activity should improve over August levels, but remain firmly entrenched in a contraction (i.e., a level under the 50 threshold).
However, it's not all sour grapes out there. Yes, persistent inflation pressures and expectations for aggressive Fed actions are again souring stock sentiment as the calendar officially turns to fall on September 22. However, supply chain pressures are easing, demand remains firm, and several market/economic watchers, including ourselves, believe an economic hard landing is still not the base case. And, notably, any potential recession is expected to be mild, given strong consumer and business balance sheets. In addition, labor conditions in the U.S. are tight, natural gas prices here and abroad are down over recent weeks, and headlines out of China have pointed to better COVID-19 trends and policy support. Bottom line: Investors should prepare for continued volatility ahead and maintain a bias for quality/income assets. And while the next 3 to 9 months could test investors' resolve, we believe longer-term investment opportunities continue to open up and benefit those willing to look past the challenges of the day.
Sources: FactSet and Bloomberg. FactSet and Bloomberg are independent investment research companies that compile and provide financial data and analytics to firms and investment professionals such as Ameriprise Financial and its analysts. They are not affiliated with Ameriprise Financial, Inc.
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