Inflation Report Eases Some Concerns While Earnings Season Wraps Up

Key Takeaways

• PCE Report In Line With Expectations
• Sensitivity To Earnings Forecasts Showing Up
• Focus Shifts To Next Week’s Employment Report

Stocks closed lower on Thursday with the S&P 500 falling 0.6% and Nasdaq Composite dropping 1.1%. Volatility, which has rebounded from its lows, closed just below 14.5, which is still low by historical standards. After yesterday’s close, a slew of earnings sent futures down even further. And thus far, this morning’s Personal Consumption Expenditures (PCE) Index report, the Federal Reserve’s preferred metric on inflation, has had a muted effect on markets.

We’ve seen a moving target when it comes to interest rate policy forecasts. Heading into this morning, few expected the Federal Reserve to make any interest rate changes until at least September, and even then, it was a 50/50 shot between a cut in rates or leaving rates alone, according to the CME Fed Watch Tool.

On a month-over-month basis, prices increased 0.3%, in line with forecasts. Core
Core
prices increased 0.2%, which was slightly below expectations of 0.3%. Looking at the year-over-year change, the 2.7% print was right in line with what was expected and the core year-over-year change of 2.8% was also as expected. The data did little to help clarify the Fed’s next move. The probability of a rate cut in September is still around 50%. After the September meeting, the Fed will not meet again until November and the forecast for a rate cut then is hovering around 60%.

It’s been a heavy week for earnings, especially in retail stocks. After the close, Costco reported numbers that beat on all metrics, but analysts were hoping the company would also announce an increase in membership prices, which the company did not do. In after-hours trading, shares of Costco fell 1.6%. Computer maker Dell, which has more than doubled this year, met analyst expectations for earnings. The company also beat on sales. However, a disappointing second quarter outlook sent shares down by 18%. Gap
Gap
Inc. surprised the street with better-than-expected earnings and the company also raised guidance, sending the stock higher by 20% in after-hours trading. Finally, both Marvell and Nordstrom missed on earnings but maintained forecasts. Both of those stocks fell by around 5%.

I want to revisit something I mentioned in my column on Wednesday and that was the extended valuations stocks are currently carrying. Dell and Gap offer great examples of what I discussed. According to FactSet, the S&P 500 trading at around 20.5x its 12-month forward looking earnings. That’s well above both the five- and ten-year averages. Therefore, either earnings need to continue growing at an accelerated rate to justify equity prices, or prices need to come down. Although Dell met on their earnings, the forward-looking guidance was not good. Subsequently, the stock was punished significantly for that. At the other end of the spectrum, Gap Inc. raised their guidance which supports carrying a higher multiple, which is likely why the stock rallied so much. The important takeaway to this is the role of forward guidance and why I strongly believe any mid quarterly updates will be so important. This is likely to be especially true in technology where, according to ChartStock, tech stock valuations are at a 23 year high.

Looking out to next week, earnings really slow down with Lululemon being one of the few bigger names scheduled to report. However, in the absence of earnings, there is a lot of economic data due out with May’s employment report being the highlight next Friday.

For today, the S&P 500 is sitting right on its 21-day moving average. A break below that could signal some bearish sentiment, at least in the short term. However, the PCE report may have alleviated some concern for markets. Over the past couple weeks, some members of the Fed indicated that an interest rate increase could potentially be necessary. I don’t think that is a realistic possibility and today’s numbers give me no reason to change my thinking. As always, I would stick with your investing plan and long term objectives.

tastytrade, Inc. commentary for educational purposes only. This content is not, nor is intended to be, trading or investment advice or a recommendation that any investment product or strategy is suitable for any person.