Early Rally Threatened After Hotter-Than-Expected Producer Price Report Sustains Inflation Worries

(Wednesday Market Open) The market received another big “risk-off” catalyst this morning from higher-than-expected Producer Price Index (PPI) data for September.

Stock index futures, which had climbed ahead of the report, gave back most of their gains but stayed slightly in the green despite a disappointing 0.4% jump in headline PPI. Analysts had expected a 0.2% monthly climb. Inflation gains were pretty evident throughout the report.

Nothing here looks like it would give the Fed any indication that its tightening is significantly slowing price growth. The CME FedWatch Tool now indicates a roughly 84% chance of a 75-basis-point hike at the Fed’s Nov. 1-2 meeting. The 10-year Treasury yield (TNX) climbed to 3.96% this morning.

Futures trading went on a roller-coaster ride overnight, but benchmark S&P 500® (SPX) futures remained above 3,600 this morning. That could be a key support area after a late sell-off yesterday took us to a close below 3,600. The resistance level to watch appears to be 3,640.

Potential Market Movers

The Cboe Volatility Index® (VIX) has been climbing this week and remained above 33 in the early going Wednesday. This level is well above normal and indicates expectations for choppiness ahead, so anyone trading should use caution.

With PPI data now in the rear-view mirror, tomorrow’s September Consumer Price Index (CPI) will be the next big number on the schedule. We’ve seen the producer side of the house, and now it’s on to the consumer side.

Analyst consensus from Briefing.com suggests we’ll see a 0.2% rise in headline CPI, with core CPI up 0.4% from a month earlier.

If CPI rises less than expected tomorrow, it might be seen as bearish. It could be a negative sign for profits if producer prices are rising and companies can’t pass those prices on to consumers. It could represent a possible hit on margins.

It’s often helpful to dive deeper into these reports beyond the headline figures to see where inflation is coming from, where it’s rising, and where it’s falling. Food, shelter, automobile, and energy costs have driven a lot of the consumer inflation so far this year. But lately there’ve been signs of retailers running into inventory build-ups and even discounting prices. We’ll see if tomorrow’s report shows signs of any pullback in prices elsewhere.

The market right now is trying to digest all the data coming in and then put it alongside some sort of Federal Reserve rate-hike path. It seems every time we’ve recently received a data point that doesn’t fit the perceived rosy outcome, the market gets some pretty big jitters. With the opening salvo for the Q3 earnings season fired from the biggest banks on Friday, be prepared for volatility.

It’s a drill that’s been going on for months without an armistice, but it’s somewhat constructive to see that the Financial Industry Regulatory Authority (FINRA) says investors are using less leverage. That could limit the volatility a bit if we see selling accelerate. Not having as much leverage could be a calming factor.

We got some important and slightly positive inflation data yesterday when the Federal Reserve Bank of New York released consumer inflation expectations for September. Expectations for inflation growth over the next year fell to 5.4%, the lowest number in a year and a decline from 5.75% in August and a peak of 6.8% in June.

The Fed has said it’s very focused on consumer inflation expectations due to worries they could become entrenched, so this report is a big-ticket item that central bankers are likely watching. Any drop, however small, is potentially helpful, because it could be evidence that households are starting to see the impact of higher borrowing costs.

In other Fed-related news, investors will be on their toes this afternoon for the latest batch of minutes from September’s Federal Open Market Committee (FOMC) meeting. The Fed’s language has been uniformly hawkish in speeches since then, but the minutes often delve deeper into Fed officials’ thinking. Some people will likely try to read between the lines for possible signs of anything that could make the Fed pause its pace of one large rate hike after another. They’ll also be looking for language indicating whether any Fed officials are concerned about tightening too much.

The earnings season gathers steam today and tomorrow ahead of big bank earnings on Friday. PepsiCo (PEP) kicked things off this morning. The food and beverage giant beat Wall Street’s earnings and revenue expectations and raised its guidance, a key positive element. Shares rose 3% in the hours before the opening bell. Several food and beverage companies have now reported over the past two weeks and their results have been generally good.

Thursday marks the first mega-earnings day, featuring Walgreens Boots Alliance WBATaiwan Semiconductor TSMDomino’s Pizza DPZBlackRock BLK, and Delta DAL. The DAL and TSM reports, in particular, could be worth watching. The chip sector has been under intense pressure amid signs of declining demand, while at the same time recent consumer surveys show consumers spending more heavily on travel.

Then many of the big banks step up to the plate Friday morning. Companies expected to report that day include JP Morgan Chase JPMMorgan Stanley MSWells Fargo WFC, and Citigroup C. Their narrative is likely to set the tone for the rest of the Q3 earnings season.

Reviewing the Market Minutes

No rally seems safe. Yesterday proved that again. After being up more than 300 points at times during the session, The Dow Jones Industrial Average® ($DJI) finished the day up only 36.31 points, or 0.12%, at 29,239.19. Strength in two $DJI components—Amgen (AMGN) and Walgreens Boots Alliance (WBA) helped keep that index barely afloat, but it was a sharp drop from midday highs. AMGN benefitted from an analyst upgrade, and WBA made gains ahead of its scheduled report of fiscal Q4 earnings tomorrow.

The SPX posted new two-year lows intraday Tuesday before closing down 0.65% at 3,588.84, while the Nasdaq-100® (NDX) fell 1.24% to 10,791.35 The Russell 2000® (RUT) rose just a smidgen. Worries about financial stability in the U.K. appeared to dash the rally late in the day. So did more hawkish Fed talk, this time from Cleveland Fed President Loretta Mester. Comments by Bank of England governor Andrew Bailey about “three days left” before the BoE halts its market support likely delivered most of the dagger.

WTI Crude (/CL) prices sank for the second-straight day, apparently taking their lower cue from rising measures against COVID-19 in China. The energy sector lost ground again, while so-called “defensive” regions of the market like consumer staples and health care were among the market leaders Tuesday.

Real estate also made healthy gains Tuesday, but its year-to-date performance remains far worse than that of the SPX amid rising mortgage rates and recession fears. It’s the worst-performing sector of the year except for communication services.

The U.S. Dollar Index (DXY) closed above 113 after falling below 111 last week. The dollar might have benefited from global financial worries following the Bank of England’s (BOE) extension of bond buying announced early Tuesday. Increased tension in Ukraine and COVID-19 issues in China may also be supporting the greenback. 

CHART OF THE DAY: INFLATION HEDGE? NOT THIS YEAR. Gold (/GC - candlestick) is frequently touted as the classic inflation hedge—an asset that can hold its value as inflation eats away at purchasing power. This year, however, as the inflation-led rise in interest rates, including the 10-year Treasury Index (TNX – purple line) drove the dollar higher, owning gold hasn’t helped offset record inflation. Quite the opposite, actually.  Data Sources: CME Group, Cboe Global Markets. Chart source: The thinkorswim® platformFor illustrative purposes only. Past performance does not guarantee future results.

Three Things to Watch

Tech Strikes Out: Through the end of last week, the S&P 500 Technology Select Sector (IXT) was down 20% from its recent August peak versus just 15% for the SPX. Other sectors are also weak since then, but why is tech getting hit harder? It’s easy to say it’s thanks to bad news like softness in the semiconductor sector, growing COVID-19 cases in China, and overall economic pain, and that’s true enough. But there’s also a more structural aspect. When the Fed had its benchmark borrowing rate fixed near zero between March 2020 and March 2022, investors couldn’t make any money in fixed income, but a theoretical tech company with no profits essentially had a free ride. The company could borrow money at very low interest, wasn’t expected to show profits, and could find easy access to capital. That kind of runway attracted investors, and the IXT rose more than 150% from its March 2020 low to its all-time high late last December.

Since then, the IXT is down one-third, and that’s partly a function of the Fed’s 300 basis-point rate increase starting in March. Suddenly, that unprofitable tech company (and many others) had to pay “real” money to borrow, and with interest rates rising, investors found they had more attractive things to do with their money (like parking it in a government bond paying 4%). With the cost of borrowing and servicing debt now so much higher there could be some debt-related pain developing in tech and other sectors where many companies have borrowed heavily. The big banks might be able to shed more light on loan quality when they report earnings later this week.

New Year’s Party Cancellation? We’re entering Q3 earnings season with many analysts and companies fiercely slicing projections for company profits. Unfortunately, the same thing might happen soon to Wall Street’s 2023 S&P 500 earnings outlook, even though it’s six months until the first of those hit our screens. The current outlook is for 7.9% year-over-year earnings per share growth for S&P 500 companies next year, according to FactSet. But research firm Briefing.com contends that’s too high. Persistently elevated inflation, rising interest rates, the strong U.S. dollar, higher energy prices, China’s continuing “zero-Covid” policy, and a reduced “wealth effect” globally due to falling stock prices all could cause that nearly 8% projection to decline, said Briefing.com. Also, if the Fed succeeds in its goal of softening the labor market, that means higher unemployment, leading to potentially lower consumer spending. All in all, not a rosy forecast.

What’s in Store? The holiday shopping season looks increasingly likely to be weaker than normal, at least judging by retail sector layoffs. Peloton Interactive (PTON) last week became the most recent consumer products company to announce job cuts. Retailers have cut 11% of their workers so far this year through September, Barron’s reported, but many firms are still working out their holiday hiring plans. Usually, retail layoffs pick up in the new year after the holidays. Last week’s Labor Department payrolls report showed a very small drop in the number of people employed in the retail services sector during September. For anyone trying to get a sense of holiday shopping trends, that could be an interesting sector category to search when the October jobs report arrives to see if it turns around.

Notable Calendar Items

Oct. 13: September Consumer Price Index (CPI) and earnings from Delta (DAL), Domino’s (DPZ), Progressive (PGR), and Walgreen’s Boots Alliance (WBA)

Oct. 14: September Retail Sales, October Michigan Consumer Sentiment (early), August Business Inventories, and earnings from Citigroup (C), JPMorgan Chase (JPM), Wells Fargo &Co. (WFC), Morgan Stanley (MS), PNC Financial (PNC), U.S. Bancorp (USB), and UnitedHealth (UNH)

Oct. 17: October Empire State Manufacturing and earnings from Bank of America (BAC)

Oct. 18: September Industrial Production, September Capacity Utilization, and earnings from Goldman Sachs (GS), Johnson & Johnson (JNJ), Lockheed Martin (LMT), United Airlines (UAL), and Netflix (NFLX)

Oct. 19: September Housing Starts and Building Permits, and earnings from Abbott Labs (ABT), Procter & Gamble (PG), Biogen (BIIB), Travelers (TRV), Tesla (TSLA), and Las Vegas Sands (LVS).

Oct. 20: September Existing Home Sales, Philadelphia Fed Index, and earnings from Alaska Air (ALK), American Airlines (AAL), AT&T (T), Dow (DOW), Whirlpool (WHR), and CSX (CSX).

Oct. 21: Earnings from American Express (AXP), Schlumberger (SLB), and Verizon (VZ).

TD Ameritrade® commentary for educational purposes only. Member SIPC.

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