Inflation report, bond yields in focus as U.S. stocks rally pauses
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[August 05, 2023] By
Carolina Mandl
NEW YORK (Reuters) - A highly awaited inflation report and elevated bond
yields offer the latest test to a U.S. stock rally that has delivered
hefty gains this year.
The benchmark S&P 500 index is up 16.6% year to date, fueled by an
improving economic outlook, excitement over developments in artificial
intelligence and signs that the Federal Reserve is close to ending its
market-bruising U.S. interest rate hikes.
Stocks' near-term trajectory, however, may depend on whether next week's
inflation report shows consumer prices remaining subdued. Investors are
also closely watching the path of Treasury yields, which rattled equity
markets in recent days by rising to fresh year highs. The S&P 500 fell
2.27% this week, its biggest weekly decline since March 10.
"After a massive run-up in equities ... any sort of blip in terms of any
of the macro data (is) probably going to be a reason for people to take
profits," said Jack Janasiewicz, lead portfolio strategist and portfolio
manager at Natixis Investment Managers.
While consumer prices have not been rising as fast lately, some
investors worry stubborn inflation may force the Fed to leave rates at
current levels longer than expected. The U.S. reports consumer price
data on Aug. 10.
On Friday, U.S. employment data showed the economy maintained a moderate
pace of job growth. Yet wages grew at a faster-than-expected annual clip
of 4.4%. Many fear that is too high to be consistent with the Fed's 2%
inflation target.
Janasiewicz of Natixis said a stronger-than-expected consumer price
reading next week could spark a decline of up to 5% in the S&P 500. He
said such a drop would be “healthy” given the index's big runup this
year.
Other investors have been taking profits. Concerns over rising stock
valuations pushed Aaron Chan, a managing partner at equity hedge fund
Recurve Capital, to trim stakes in shares of companies including
Amazon.com, which is up 68% this year, and Norwegian Cruise Line, up
47%.
The S&P 500 is trading at about 19.5 times forward 12-month earnings
estimates, much pricier than its long-term average of about 15.6 times,
according to Refinitiv Datastream.
Rising global prices for oil and food, which the Fed's rate increases do
little to control, may have more sway on inflation in coming months,
said Tim Murray, a capital markets strategist at T. Rowe Price.
Prices for Brent crude were on track for their sixth straight week of
gains, up roughly 17% in that period on signs of tightening global
supply and rising demand.
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The U.S. flag is seen on a building on
Wall St. in the financial district in New York, U.S., November 24,
2020. REUTERS/Brendan McDermid
"As long as CPI remains flat to trending down, the market will
accept it thoroughly," said Ann Miletti, Allspring's head of active
equity. "If we do see upticks, it is really dependent on where the
upticks are and whether or not investors believe they're temporary
in nature."
Miletti is growing more bullish on corners of the market that have
underperformed, including small cap stocks.
A stronger-than-expected inflation number next week could also boost
Treasury yields further. Yields, which move inversely to bond
prices, spiked this week following a downgrade of the U.S. credit
rating by Fitch and on the prospect of a flood of Treasury supply in
the third quarter. The benchmark 10-year yield fell sharply after
Friday's jobs report but remained above 4%, a level last seen in
November 2022.
Rising yields on Treasuries, viewed as among the world's safest
investments because they are backed by the U.S. government, can dull
the allure of stocks. Projected company cash flows are also worth
less in current dollars when interest rates rise.
"The move in the 10-year U.S. Treasury yield above the 4% level will
likely act as a headwind to further expansion in already lofty
equity valuations," Keith Lerner, co-chief investment officer at
Truist Advisory Services, wrote this week.
There is still plenty of good news to keep the rally going. Earnings
from Wall Street heavyweights Amazon and Google-parent Alphabet have
exceeded analysts expectations, though disappointing earnings from
Apple sent the stock tumbling 4.8% on Friday.
More broadly, more than 79% of S&P 500 companies have beaten
estimates for the second quarter so far, the highest beat rate since
the third quarter of 2021, data from Refinitiv I/B/E/S showed.
The past week also saw analysts from BofA Global Research and
JPMorgan revise their forecasts for a U.S. recession.
Still, some market participants believe investors may have to endure
some near-term turbulence.
"Our expectation is that the market takes some time to digest the
strong year-to-date gains and moves into a choppy period," Lerner
said.
(Reporting by Carolina Mandl in New York; Additional reporting by
Lewis Krauskopf; Editing by Ira Iosebashvili and David Gregorio)
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