This morning, equity futures on Wall Street dropped sharply after release of another “hot” reading on U.S. inflation. At 8:30 A.M. (EDT), the Labor Department reported that consumer prices for the month of September rose 0.4%, which came in above expectations. When stripping out the more volatile food and energy components, the core Consumer Price Index (CPI) increased 0.6%, which was also higher than expected. On a 12-month basis, the CPI was up 8.2%, and 6.6% when excluding food and energy. The equity futures, which had been higher on news of a scaled down proposed United Kingdom tax-cut plan, significantly shifted course and are now suggesting a markedly lower start to the trading day stateside. Treasury market yields also spiked on the CPI data.
The CPI report comes on the heels of yesterday’s release of the Producer Price Index (PPI). That report showed inflation remains stubbornly higher on the wholesale level. In September, both the PPI and the core-PPI climbed 0.4%, with the former figure coming in double the August reading of +0.2%. For the 12-month period ending September 30th, the PPI jumped 8.5% and 5.6% excluding food and energy prices. The PPI data did not quell the investment community’s sentiment that the Federal Reserve will remain aggressive on the monetary policy front through the end of this year.
The same conclusion is suggested by the minutes from the September Federal Open Market Committee (FOMC) meeting, released yesterday afternoon, which continued to show a very hawkish stance by Fed policymakers. The minutes indicated a majority view that the ongoing interest-rate hikes are appropriate. In addition, many participants stressed the need to keep tightening monetary policy even if labor market conditions slowed, and that the central bank needs to get the benchmark short-term interest rate to the 2022 federal funds target rate of 4.40% and keep it there for a while to fight inflation. The Fed leaders also noted that liquidity risk (or a “credit crunch”) in the lending market remains low. Thus, risk of such a crunch is not likely to pose a roadblock on the Fed’s path to getting rates to a level that will slow demand enough to push prices lower. The minutes did not surprise anyone and the market reacted little to them on Tuesday.
The hawkish Fed minutes did put more upward pressure on the price of the U.S. dollar against a basket of international currencies. The stronger dollar, along with rising Treasury market yields, has not been a good backdrop for equities. This environment, combined with concerns about third-quarter earnings season (more below), are weighing on stocks and may continue to make for a volatile performance as we move toward year’s end. The elevated borrowing costs have pummeled the higher-growth technology stocks, and after holding up relatively well earlier in year, the issues of the mega-cap technology names have struggled mightily in recent months.
The elevated lending rates, which saw the average rate on the 30-year fixed mortgage climb above 7.00% this week, also are hurting the performance the of the housing and homebuilding companies. Not surprisingly, the homebuilding stocks have been beaten down this year on sentiment that we are in the midst of a housing recession.
Now with both September inflation and employment data known, the attention of Wall Street for the next fortnight will likely turn to Corporate America, with third-quarter earnings season unofficially commencing tomorrow morning with the latest quarterly results from JPMorgan Chase (JPM). That report, along with a slew of earnings data from a number of the other big banks, will provide snapshots on how both the U.S. economy and the corporate world are faring. It is worth noting that the earnings growth estimate for S&P 500 companies has come down notably in recent weeks and now the consensus forecast is calling for low single-digit growth.
In general, the stocks of the companies that have either posted weak results or warned that the last quarter was a difficult one have felt the wrath of investors. After yesterday’s closing bell chipmaker Applied Materials (AMAT) lowered its earnings forecast for the fourth quarter and its shares were down in extended hours trading. However, those companies that have bucked this trend, including PepsiCo. (PEP), Delta Air Lines (DAL), and Walgreens Boots Alliance (WBA) in the last 24 hours, have been greeted positively. Shares of all three got a boost after the companies beat earnings expectations and raised their full-year earnings forecasts.
With all the economic and financial market variables in play right now and the expectation that they will lead to a volatile near-term performance for stocks, we recommend that investors maintain a cautious investment approach. This includes focusing on high-quality companies that have strong finances and ample cash flows, which will allow them to maintain their dividends. Given the higher Treasury market yields, investors, particularly those with an eye for income, are targeting those stocks that provide a steady and competitive stream of income. The higher fixed-income yields are hurting the utility stocks, as their yields don’t look as attractive right now and they tend to offer little in the way of earnings growth potential. – William G. Ferguson
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
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