Stocks Tumble After Hot Inflation Report – What to Expect Next

The markets were in tumult on Wednesday as a sizzling inflation report sent shockwaves through Wall Street, erasing over 420 points from the Dow Jones Industrial Average. The catalyst? A March inflation report that came in hotter than expected, setting the stage for a potential reset in Federal Reserve interest rate expectations.

Investors reacted sharply to the news, driving up benchmark 10-year Treasury yields to levels not seen since November and sparking concerns about the broader implications for equities. However, amid the frenzy, an important piece of the inflation puzzle seems to have been overlooked, potentially spelling trouble as we head into earnings season.

The Commerce Department’s latest data revealed that headline inflation accelerated to an annual rate of 3.5% in March, with core inflation, which excludes volatile food and energy prices, hitting 3.8%. This uptick was largely attributed to surges in gas and rent prices, according to Jamie Cox, managing partner for Harris Financial Group.

“Over half of the increase in CPI is gas and rents, which is keeping inflation north of 3%,” notes Jamie Cox, managing partner for Harris Financial Group.$SPY $QQQ

— Kaar Investments (@kaarinvestments) April 10, 2024

Despite these numbers, Jamie Cox remains confident that interest rates won’t rise further in the near term, although he suggests that a rate cut may still be some way off.

The broader market picture reveals that while the S&P 500 remains up 8.8% for the year, its resilience will face a stern test as earnings season kicks off, starting with JP Morgan later this week.

The response in rate markets echoes this sentiment, with the likelihood of a June rate reduction plummeting to just 18.8%, down from 51% prior to the inflation report and a high of 74% earlier this year.

However, the surge in inflation comes alongside a string of robust economic indicators for March, including impressive job creation numbers and strong service-sector activity. These positive signals point to a healthy GDP growth rate for the first quarter, with the Atlanta Fed’s GDPNow tool estimating growth at around 2.4%.

“The U.S. economy is proving to be incredibly resilient,” notes Skyler Weinand, chief investment officer at Regan Capital. Weinand suggests that the Fed’s next move could involve a rate hike to counter inflationary pressures and maintain economic stability.

CPI Update

Even if CPI moderates from +0.40% to +0.30% for the next 12 months, the annualized number will actually rise going into the election. pic.twitter.com/I2dlSVoZrt

— Skyler Weinand (@sweinand) April 10, 2024

Nevertheless, the recent market turmoil underscores a shift in financial market dynamics. The expected adjustments to the Fed’s rate-cut forecasts for 2024 could prompt a reassessment of asset valuations, translating into potential downward pressure on stock prices.

With a higher risk-free rate applied to asset pricing, the S&P 500’s current valuation, trading at around 21.2 times projected profits for the next 12 months, may appear overstretched. This valuation sensitivity is heightened by market conditions that demand near-perfect economic data to sustain current levels.

David Bahnsen, chief investment officer at Bahnsen Group, underscores the market’s sensitivity to earnings and valuation metrics. Bahnsen emphasizes that while market direction remains robust, there’s a significant reliance on upcoming earnings reports to validate current market valuations.

As we enter earnings season, expectations are high. Collective first-quarter S&P 500 profits are projected to rise by 5% year-over-year, with an estimated total of $457.4 billion. Looking ahead to the second quarter, earnings growth is expected to accelerate to 10.3%, reaching profits of $494.1 billion.

However, if economic data can trigger sell-offs, any shortfall in earnings growth relative to expectations could exacerbate market corrections.

John Lynch, chief investment officer for Comerica Wealth Management, highlights the growing importance of earnings delivery in sustaining market momentum. Lynch warns that profit disappointments could lead to a near-term correction in the S&P 500.

Richard Saperstein, chief investment officer at Treasury Partners, echoes these sentiments, emphasizing the critical role of earnings in driving future market gains. With stock valuations at record highs, Saperstein suggests that expected earnings growth in the coming years may not be sufficient to fuel significant market appreciation from current levels.

In summary, the latest inflation report has injected volatility into the markets, raising questions about the path ahead for interest rates and asset valuations. As earnings season unfolds, all eyes will be on corporate performance to determine whether current market levels can be sustained or whether further adjustments lie ahead.

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