This morning the attention of Wall Street was again on the U.S. inflation situation. At 8:30 A.M. (EDT), the Labor Department reported that the Producer Price Index (PPI) for the month of June increased 0.1%, which was less than the consensus expectation of 0.2%. When backing out the more volatile food and energy components, the core PPI also increased 0.1%. Both figures suggest that inflation is cooling at the producer (wholesale) level. On a 12-month basis, the PPI increased 2.4%, which should comfort the Federal Reserve, as producer price growth is running close to the central bank’s desired target of 2.0%. Meantime, initial jobless claims for the week ending July 8th totaled 237,000, which was down 12,000 from the previous week. The equity futures, which were higher heading into the economic releases, are still pointing to some buying at the start of the trading day stateside.
The producer price data came on the heels of yesterday’s companion report on consumer prices. In sum, the Consumer Price Index (CPI) showed a softening in prices at the consumer level. Specifically, the CPI rose 0.2% on a month-to-month basis in June, which was up modestly from the May pace, but came in below the consensus expectation of +0.3%. The core CPI, which excludes food and energy, increased 0.2%, the slowest pace in two years. On a one-year basis, the CPI climbed 3.0%, down significantly from the May rate of 4.0%. The relatively benign price figures were greeted kindly by an investment community that is hoping the Federal Reserve is nearing the end of its interest-rate hiking cycle. Treasury market yields fell and stocks rallied yesterday, with the tech-heavy NASDAQ Composite leading the way with a gain of 1.2%.
The Federal Reserve, which will hold its two-day Federal Open Market Committee (FOMC) meeting on July 26th-27th, has said it will be “data driven” in its task of formulating future monetary policy. Thus, yesterday’s report showing a softening of consumer prices, raised sentiment on Wall Street that after the central bank likely raises the federal funds rate by a quarter point, to 5.25% to 5.50%, at this month’s meeting, it may reconsider its hawkish monetary policy stance for the remainder of this year. In particular, the higher-growth, but often less profitable technology names got a boost from the drop in the Treasury market yields. Likewise, the stocks of many of the multinational names performed well yesterday after the more benign inflation data pushed the price of the dollar lower versus a basket of international currency. A weaker greenback is beneficial to the multinational companies, as their profits from overseas when translated back into our own currency are enlarged, giving a boost to earnings.
Meantime, second-quarter earnings season is set to kick off tomorrow, with quarterly results from a number of the big banks. Before tomorrow’s opening bell, industry heavyweight JPMorgan Chase (JPM) will release results. The investment community will be closely watching the profit and loan growth figures, as well as the loan loss reserve taken by the bank. If the banks increase their loan loss reserves, it could be a sign of some difficulties ahead, resulting from the Fed’s highly restrictive monetary policy course over the last 16 months. There are concerns on Wall Street about huge unrealized losses resulting from the poor performance of the bond market over the last year and a half. Additionally, the banks with high loan exposure to the struggling commercial real estate market also may have some elevated near-term operating risks. This group is mostly comprised of regional lenders.
The equity market has rallied nicely over the first six-plus months of 2023 on the expectation that the Federal Reserve, which as noted said it plans to be data dependent in formulating monetary policy, is near the end of its interest-rate hiking cycle. In recent weeks, a “Goldilocks” backdrop, which includes moderate growth at a time when inflation is cooling, is also giving a boost to equities, as it raises the hope that the Fed can orchestrate a “soft landing” for the economy. The Fed’s Beige Book summation of economic conditions (released at 2:00 P.M. (EDT) yesterday) confirmed this scenario, as it showed that the economy is expanding but at a slower pace, while prices are increasing at a moderate rate and the expectation is calling for inflation to slow in the coming months.
The buying, including yesterday’s move higher, though, has pushed the price-to-earnings valuation for S&P 500 companies to around 19 times. That figure is above its 10-year average of 17.4x. It should be noted that the technology, communication services, and industrial sectors hit 52-week highs during yesterday’s bullish session. However, with market valuations looking frothy, any misstep by a company and/or disappointing macroeconomic event could potentially trigger some selling. In this environment, we continue to recommend that investors continue hold the stocks of high-quality companies with strong balance sheets and a history of generating steady earnings and cash flows. - 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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