U.S. stock investors are turning their attention to next week’s inflation data, which could determine the short-term course of a stock rally that has faltered in recent weeks.
Signs that the U.S. economy is on track for a so-called soft landing, in which the Federal Reserve is able to reduce inflation without severely hurting growth, have helped lift the S&P 500 since the start of the year increased by 16 percent.
Last week’s jobs data played a role in that narrative, showing that the labor market remained robust, although not strong enough to fuel fears that the Fed would need to raise interest rates even further to combat inflation – moves that have markets worried rocked last year.
Next week’s consumer price data may need to strike a similar balance, investors said. Too high a number could raise fears that the Fed will keep interest rates high for an extended period of time or raise them more in the coming months. That would give investors less reason to hold on to stocks after the S&P 500 lost about 5 percent from summer highs due to a technology-related decline.
“This inflation demon is far from destroyed,” said Michael Purves, chief of Tallbacken Capital Advisors, who expects signs of higher inflation to weigh on metrics of the megacap growth stocks that have driven the rally.
“If we experience structural change with higher nominal GDP growth, that will come with some volatility and unintended consequences.”
Investors trying to gauge the Fed’s future policy will also be keeping an eye on other data in the coming week, including the producer price index and retail sales.
The Federal Reserve is widely expected to keep interest rates stable at its meeting on September 20. Markets are also pricing in a nearly 44 percent chance of a rate hike at the Fed’s November meeting, up from 28 percent a month ago.
“If we get high inflation data, those expectations will rise significantly for September and November,” said Randy Frederick, managing director of trading and derivatives at the Schwab Center for Financial Research.
Despite the recent fluctuations in the stock market, strategists and investors are largely confident in the market at the moment. However, some are becoming more cautious.
Reasons for optimism include the U.S. economy’s relative outperformance compared to Europe and China, as well as signs that the so-called earnings recession among S&P 500 companies may be over.
Still, concerns about an economic slowdown in China and fears that U.S. companies’ margins could shrink have led some market participants to believe it will be harder to extract further profits from stocks.
The S&P 500 information technology sector lost more than 2 percent this week after news that Beijing had ordered central government employees to stop using iPhones for work. Apple shares fell 6 percent this week amid fears that the company and its suppliers could be hit by increasing competition from China’s Huawei.
“We believe we are still in a bull market that will reach new highs before the end of the year, but it will be a bumpy road,” said Ed Clissold, chief U.S. strategist at Ned Davis Research.
The S&P 500 is down about 5 percent from its July highs, making equity valuations more attractive overall given the low probability of an impending recession, said Jonathan Golub, senior equity strategist at Credit Suisse Securities.
He noted that forward price-earnings multiples for 10 of the S&P 500’s 11 sector groups fell in August, although the P/E ratio for the index as a whole remains near 20, compared to 17 at the end of 2022.
Still, much of the bullish case for stocks depends on inflation weakening and ultimately pushing the Fed to lower interest rates.
“If we were to see another significant rise in interest rates, the stock market wouldn’t be able to handle that as well,” said David Lefkowitz, head of U.S. equities at UBS Global Wealth Management.
Updated: September 9, 2023, 2:15 p.m
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