Can US stocks extend the upleg? Inflation worries linger ahead of key jobs data.

Investors took a breather this week as US stocks rebounded from a week-long sell-off and the latest inflation data offered a glimmer of hope for those hoping for a peak in price pressures.

However, strong inflation concerns remain beneath the surface. The April reading on the Federal Reserve’s preferred measure showed a slowing in inflation, but that alone wasn’t enough to end the debate over where price hikes will go from here. And stocks can typically recover even when they’re already in a bear market or poised for a bear market, said Wayne Wicker, chief investment officer of Washington-based MissionSquare Retirement, which has $33 billion under management.

With the S&P 500 Index and Nasdaq breaking a streak of seven straight weekly declines and the Dow Jones Industrial Average DJIA,
After ending a streak of eight consecutive weekly declines on Friday, it could be easy to look past the recent volatility that has gripped financial markets since mid-May.

See: Why the Dow Finally Bounced — and What It Takes to Convince Investors It’s Real

However, history shows that inflation can persist long after the Federal Reserve begins raising interest rates. Consumer sentiment is currently at a 10-year low, while declining corporate profit margins pose another threat to the S&P 500 SPX,
says John Higgins of Capital Economics, who sees the index bottoming out at 3,750 versus Friday’s close near 4,158.

The ability of a single company like Target Corp.
or Snap Inc.
Issuing a lost earnings announcement or warning that triggers broader stock sell-offs signaled a sharp shift in market thinking toward insidious inflation and could cause parts of next week’s non-farm payrolls report to become stale.

Portfolio manager Scott Rüsterholz of Insight Investment, which manages $1.1 trillion in assets, points to the number of tech companies that have fallen since 12 months of official data.

“The volatility stemming from individual company announcements is the highest since 1987,” Ruesterholz said over the phone. “The reason for such outsized moves is that we have very little confidence in the inflation outlook.”

“Often the job market tends to lag behind fluctuations in the economy, and this is especially true during periods of significant volatility,” said the New York-based portfolio manager, who believes US job market tightness has peaked. “Employment data is going to matter a little less, especially if the number is strong, because you’re going to wonder if that’s still the case today.”

Rüsterholz said he expects wage growth to slow to 275,000 in May from 428,000 the previous month, below the consensus estimate for a 325,000 job gain in a Wall Street Journal survey of economists. The data will be published next Friday. Beyond that, he says, “the market is likely to strip payroll numbers” while giving more consideration to the reading of average hourly earnings, which he expects to moderate.

Contributing to this week’s rebound in equities was a feeling among many investors that Fed policymakers may need to refrain from aggressive rate hikes until year-end given the likely impact on economic growth. Traders have scaled back their expectations of how high the key interest rate target can get in 2022.

“This concept that the Fed is going to back down for whatever reason is totally misguided,” said Thomas Simons, Jefferies money market economist. “The Fed is much more focused on inflation and less concerned about deflating the financial market going forward.”

With fixing traders forecasting five more annual headlines above 8% in the CPI from May to September, the question is whether consumers will be able to weather further increases in inflation and continue to support growth for the remainder of this year and 2023, Simons told MarketWatch.

Meanwhile, “the negative sentiment is going to be in play for a while,” Simons said. “Financial assets are going to look very, very cheap at some point and I think there will be some support for equities even at a time when markets are going sideways.”

Despite the rebound in US stocks this week, the Nasdaq Composite COMP,
remains firmly in a bear market, more than 20% off its peak while the S&P 500 briefly flirted with one. This is the case even after just two Fed rate hikes that have left the Fed Funds rate target between 0.75% and 1%. Traders see a more than 50% chance that the central bank will raise the Fed Funds rate target to 2.5%-2.75% by December, while policymakers have conceded they are likely to make a few more hikes.

Friday’s reading on the Fed’s preferred measure of inflation, known as the Personal Consumption Price Index, showed that price pressures eased in April. The inflation rate slowed last year from a 40-year high of 6.6% in March to 6.3% last month, the first drop in a year and a half. However, investors have seen “head faking” before, when a seemingly weak inflation number overshadowed the greater momentum of still-fast-rising costs.

Recent volatility in financial markets is an indication of how quickly investors are willing to put aside even positive economic data in an environment of higher inflation. Case in point, April retail sales figures released on May 17 rose 0.9%, giving many investors reason to believe the economy is still strong. Stock investors cheered the news that day, only to see the Dow Industrials slip nearly 1,200 points on May 18 while posting its worst daily plunge in about two years, as stagflation fears took hold and higher expenses weighed on retailers’ quarterly earnings.

However, most downside moves in stock values ​​”can be fully explained by falling multiples, not falling earnings,” said Ed Al-Hussainy, a New York-based senior interest rate and currency analyst at Columbia Threadneedle Investments, which manages $699 billion ( as of March).

Related: Here’s the real reason the stock market is spiraling — and it’s not because of weak earnings

Over the past 20 years, more than half of the S&P 500’s strongest days have occurred during bear markets, according to MissionSquare Retirement’s Wicker. “So it’s entirely possible, even after a week like this that’s moving us higher, that we’re seeing greater volatility that could take markets lower in the coming months,” he said.
“Next week’s jobs data really takes a back seat as people focus on Federal Reserve meetings and where inflation rates are headed right now.”

May’s Nonfarm Payrolls report, released on June 3, is the culmination of the holiday-shortened week that lies ahead. US financial markets, including the New York Stock Exchange, will be closed for Memorial Day on Monday.

If there’s an upside surprise in jobs gains, plus a stronger-than-expected 3.6% drop in unemployment in April, “it strengthens the case for rapid monetary tightening, which the Fed is on course for every 50 basis point hike.” holds in June and July,” said Bill Adams, Toledo, Ohio-based chief economist at Comerica Bank. And if the pace of job gains continues into the next few months, policymakers could climb another half-point in September, he said.

By contrast, a big miss would “carry less urgency to get interest rates back above 2% or 3%” — suggesting a pause or a reduction in the size of moves, Adams said over the phone.

Tuesday’s US data releases include the S&P CoreLogic Case-Shiller National Home Price Index for March, the Chicago Purchasing Managers’ Index for May and the Conference Board’s Consumer Confidence Index for May. The next day brings the final reading of the S&P Global US Manufacturing PMI for May, the ISM Manufacturing Index and the Fed’s Beige Book Report, as well as April data on vacancies, layoffs and construction spending.

Thursday’s data releases include Automatic Data Processing’s May private sector employment report, weekly initial jobless claims and revisions to first-quarter productivity and unit labor costs.

Friday brings May data on the US unemployment rate from the Labor Department, average hourly wages, labor force participation, the S&P Global US Services PMI for May and the ISM Services Index. Can US stocks extend the upleg? Inflation worries linger ahead of key jobs data.

Brian Lowry

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