Consumer price data will be the biggest test for the US stock market rebound

A rally that has pulled U.S. stocks off the edge of a bear market will face a significant test next week, when consumer price data provides insight into what more the Federal Reserve will need to do in its battle. against the worst inflation in decades.

Despite a turbulent week, the S&P 500 is still up more than 5% from last month’s lows, when the benchmark extended its decline to nearly 20% from its all-time high. The index recently fell about 14% from its January 3 high after losing 1% last week.

More upside could hinge on whether investors believe policymakers are making progress in the face of soaring prices. Signs that inflation remains strong could bolster the case for more aggressive monetary tightening, perhaps spooking a market battered by fears that a hawkish Fed could deal a serious blow to US growth.

“This market will likely remain limited until we get a meaningful drop in inflation,” said Mona Mahajan, senior investment strategist at Edward Jones, who currently favors large-cap stocks over small-caps, being given the ability of large firms to absorb higher input costs and wages. “Obviously the impression next week will be key.”

The consumer price index for the 12 months to April rose 8.3%, from an annual rate of 8.5% recorded the previous month, which was the largest year-on-year gain. each other in 40 years.

Friday’s inflation report for May is one of the last key data ahead of the Fed’s June 14-15 meeting, when the central bank is expected to raise rates another 50 basis points.

If inflation “continues to be a problem, the Fed may not have the ability to let go later this year,” said Paul Nolte, portfolio manager at Kingsview Investment Management. “The higher the interest rates, the greater the struggle for the market.”

Mr. Nolte broadly reduced equity positions in the portfolios he manages, particularly in growth stocks, and raised cash levels, pointing to factors such as still high stock market valuations.

The CPI report comes as investors gauge how the Fed’s 75 basis points of monetary tightening this year so far is affecting growth. Jobs data released on Friday showed U.S. employers hired more workers than expected in May and maintained a solid pace of wage increases, signs of strength that could keep the Fed on an aggressive tightening path monetary policy.

Meanwhile, gloomy views from several business leaders, including JPMorgan Chase’s Jamie Dimon and Tesla’s Elon Musk, weighed against hopes the central bank could rein in inflation without hurting the economy.

Mr Musk said in an email to executives he had a ‘super bad feeling’ about the economy and needed to cut around 10% of jobs at the electric car maker, Reuters reported on Friday .

Investors’ views on inflation are critical in valuing stocks, as rising prices have generally prompted the Fed to raise interest rates, with rising bond yields in turn reducing the value of future earnings on stocks. businesses. Rising prices also increase costs for businesses and consumers.

The S&P 500 is trading at around 18.7 times its past 12-month earnings, a rich valuation relative to other inflationary periods that suggests to investors that the current level of price increases may not last, according to Jeff Buchbinder. equity strategist at LPL Financial.

LPL believes inflation will eventually come down this year and the companies have strong earnings momentum. The company’s year-end target on the S&P 500 is between 4,800 and 4,900, which at the low end was about 16% above the index level on Friday. afternoon.

Others were less optimistic. Strategists at Morgan Stanley this week called the latest bounce a “bear market rally” and, citing negative trends for earnings and economic indicators, forecast the S&P 500 to fall to around 3,400 by mid-August.

“There’s a consensus that we’ve probably seen the high prints or inflation spikes in the rearview mirror,” said Art Hogan, chief market strategist at National Securities.

“If this turns out to be wrong…it will tip the basket of apples for the markets.”

Updated: June 05, 2022, 05:00

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