Optimists Club: Positive Feelings Build Ahead Of Tomorrow's CPI Data As Recent Inflation Signs Soften

(Tuesday market open) An uneventful start to the week belies the excitement ahead. Inflation data and earnings season loom, with tomorrow’s Consumer Price Index (CPI) representing the opening salvo.

There’s a strong likelihood that Wednesday’s eagerly awaited June CPI report will have a “3” as the first digit in the year-over-year headline inflation growth figure. In fact, that number could be as low as 3% on the dot, making it the softest year-over-year rise in more than two years. Perhaps in anticipation of a bullish report, stocks are climbing in premarket trading this morning and building on Monday’s light gains.

It’s misguided, though, to make too much of the headline CPI data. The June 2022 month-over-month CPI marked the peak of the 2021–2022 inflation surge as crude oil prices (/CL) soared. We’ve now lapped that report, meaning the comparison to last year is much “easier.” This plays heavily into headline CPI. It could be influential on Wall Street, potentially giving stocks a psychological lift.

Veteran investors (and the Federal Reserve) are likely to instead focus on core CPI, which eliminates volatile food and energy prices. Core CPI rose 5.3% in May, far above the 2% Fed target and the headline CPI of 4% that month. Core inflation for June could ease to around 5%, according to the consensus analyst estimate from Trading Economics. That’s still unpleasantly high and likely keeps a July Fed rate hike on the front burner.

Trading could be lackluster ahead of the data amid a dearth of near-term catalysts. Bullish momentum appears to be declining, which is partly a function of high forward valuations and an aggressive Fed. With earnings season starting later this week, the pressure is on companies to meet or exceed Q2 earnings expectations after a 5% rise in the S&P 500® Index (SPX) since June 1.

Chips were among the strongest sectors Monday, with the Philadelphia Semiconductor Index (SOX), jumping about 2%. Small-caps also rebounded to near recent highs. Industrials gained while mega-cap info tech continued to struggle. A falling dollar and sliding Treasury yields this morning—signs perhaps of positive feelings ahead of CPI—gave stocks another tailwind going into the data and earnings ahead.

Morning rush

• The 10-year Treasury note yield (TNX) fell four basis points to 3.96%.
• The U.S. Dollar Index ($DXY) slid to 101.89, the lowest since mid-May.
• Cboe Volatility Index® (VIX) futures inched down to 14.89.
• WTI Crude Oil (/CL) rose to $73.5 per barrel.

Eye on the Fed

Futures trading indicates a 95% probability that the Federal Open Market Committee (FOMC) will raise interest rates by 25 basis points at its July 25–26 meeting, according to the CME FedWatch Tool. However, the market is coalescing behind the idea that a hike this month will be followed by a pause in September, with a 75% chance of that scenario built into futures.

Treasury yields eased from recent peaks early this week following the release of soft Chinese economic data and Atlanta Fed President Raphael Bostic’s remarks reiterating that the Fed could meet its 2% inflation target without additional rate hikes. Last week’s U.S. economic and wage data suggested the economy continues to grow, however. The Atlanta Fed’s GDPNow indicator for Q2 Gross Domestic Product (GDP) growth rose to 2.3% Monday from the previous estimate of 2.1%, and analysts’ consensus for GDP is also on the rise—a bearish development for Treasuries.

Speaking of Fed speakers, St. Louis Fed President James Bullard took the podium today. In his last speech, he called for two more rate hikes this year because inflation isn’t slowing fast enough.

The Fed will publish its Beige Book on economic conditions around the country tomorrow afternoon, and on Thursday evening Fed Gov. Christopher Waller will deliver a speech on the economic outlook. Stay tuned.

What to Watch

Inflation check: The Labor Department will release the June CPI and PPI reports tomorrow and Thursday, respectively. These two indicators outshine all other data this week now that Nonfarm Payrolls is in the rear-view mirror. CPI data is due at 8:30 a.m. ET Wednesday.

Consensus on Wall Street for CPI, according to Trading Economics:

• CPI: +0.3% month-over-month, versus 0.1% in May
• Core CPI: +0.3% month-over-month, versus 0.4% in May
• Annual CPI: 3.1%, versus 4% in May
• Annual Core CPI: +5.0%, versus 5.3% in May

Assuming analysts’ expectations aren’t far off, it seems unlikely that the CPI data would affect the Fed’s rate strategy.

A couple indicators early this week raised optimism around the inflation picture. Wholesale used car prices fell more than 4% in June from the May reading, according to Manheim Market Insights. And the June Small Business Optimism Index rose more than expected to the highest level this year, with the share of U.S. small businesses raising prices at its lowest level in more than two years.

Producer prices don’t receive as much attention as their CPI brethren, though they can be a helpful barometer for determining future CPI. Consensus on Wall Street is for a 0.2% increase in both headline and core PPI month-over-month, according to Trading Economics. The corresponding numbers from May were -0.3% and +0.2%.

Stocks in Spotlight

Amazon’s AMZN Prime Day event today and tomorrow offers a chance to check consumer demand. For comparison’s sake, consumers purchased more than 300 million items during last year’s Prime Day, Amazon said. Prime day results generally help inform the company’s Q3 guidance, so a strong performance might translate into a better earnings outlook when Amazon reports later this month.

Keeping it domestic: The industrials sector sparkled late last week and continued to do so on Monday as shares of Caterpillar CAT, Honeywell HON, Lockheed Martin LMT and Cummins CMI popped.

Industrials is among the S&P sectors with the most revenue exposure to the domestic economy, according to FactSet, so strength implies that investors are betting on U.S. growth. Industrials outperformed info tech the last couple of sessions, and info tech happens to be the sector with the largest portion of international revenue, according to Factset. China’s slower-than-expected reopening could be an influence on this divergence in sector performance, though a couple of sessions aren’t a trend.

The Chinese and U.S. economies remain intertwined despite tense political relations and years of tit-for-tat sanctions. Recent signs of deflation in China—still the “world’s factory”—don’t necessarily bode well for the U.S. economic landscape. Investors seeking opportunities outside of tech should watch Chinese data closely for signs of more persistent weakness, as it could indicate softer U.S. and European demand for products made in China.

Talking technicals: The Nasdaq 100 (NDX) on Monday continued to pull back from resistance above 15,200, near the March 2022 peak. It hasn’t finished higher than 15,239 since January 2022.

June jobs: Last week’s Nonfarm Payrolls report delivered a mixed picture of the jobs market, but underlying wage strength is likely to keep the Fed in hiking mode, according to recent analysis by Schwab’s chief investment strategist Liz Ann Sonders and senior investment strategist Kevin Gordon.

CHART OF THE DAY:  SHOUTING DISTANCE. The tech-heavy Nasdaq 100 (NDX—candlesticks) is closing in on technical resistance near its March 2022 high close just above 15,200 (red line). It hasn’t been able to quite reach that particular peak yet, but the 50-day moving average (blue line) is climbing quickly and could conceivably represent a first zone of technical support on any pullback. Data source: Nasdaq. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Thinking cap

Ideas to mull as you trade or invest

Point of view: For months, analysts fretted about the lack of “breadth” in the broader stock market. A few high-flying mega-cap tech stocks (we all know which ones) arguably distorted the major indexes with their massive market capitalizations, causing the SPX to soar even while most sectors treaded water. Now there’s movement down below, so to speak, and that’s arguably healthy. A rally carried by just a few big names can easily fizzle with a poor earnings report or even a regulatory or geopolitical event. When more sectors participate, disappointing news in one heavily weighted sector doesn’t necessarily result in a sharp downturn for the overall market. The tough part is that even if the rally broadens, those same heavyweights remain dominant in terms of market cap, with the top eight stocks in the SPX now accounting for about 30% of the index’s value. That means there could be a nice uptick in sectors like financials, industrials, materials, and others that doesn’t move the needle much for the SPX. Look beyond the main indexes to understand the full picture.

Net-net: This Friday’s big-bank earnings reports start with the biggest bank of all—JPMorgan Chase (JPM). The company kicked off the last two earnings seasons with positive outcomes, beating analysts’ Q4 and Q1 earnings per share (EPS) and revenue estimates. Chase enjoyed a tailwind the last two quarters from net interest income (its revenue from lending minus what it pays to customers). Last time out, the company raised its guidance for net interest income to $81 billion for the year, up $7 billion from its previous forecast.  One thing to watch Friday is whether the company addresses the changing rate picture and how it might affect net interest income.

Pause button still relevant? While last week’s Nonfarm Payrolls report’s strong wage growth reinforced expectations of a rate hike later this month, it’s helpful to track the outlook for the Fed’s September meeting for clues about the long-term rate path. Chances of a follow-up 25-basis-point rate increase that month fell to 20% on the CME FedWatch tool on Monday, down from 27% late last week. That means there’s still a strong sense that the Fed could adopt a “one-on, one-off” approach to hiking and pausing. This week’s inflation data are the wildcards, of course. And speaking of June wage growth: It’s running at about 4.4% year-over-year, which is well above the trend the Fed would like to see for confidence about inflation falling to its 2% target.

Calendar

July 12: June Consumer Price Index (CPI), Core Consumer Price Index, and the Fed’s Beige Book

July 13: June Producer Price Index (PPI) and expected earnings from Conagra (CAG), Delta Airlines (DAL), and PepsiCo (PEP)

July 14: University of Michigan July Preliminary Consumer Sentiment and expected earnings from JPMorgan Chase (JPM), Citigroup (C), Wells Fargo (WFC), and UnitedHealth (UNH)

July 17: July Empire State Manufacturing.

July 18: June Retail Sales, and expected earnings from Bank of America (BAC), Morgan Stanley (MS), Lockheed Martin (LMT), and PNC (PNC).

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

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