April 27, 2024: U.S. Stock Market Outlook: Inflation Concerns, Corporate Earnings, and FOMC — Three Variables at Play

Market Tension Ahead of PCE Index Release

On April 26, the U.S. market was wrapped in considerable tension as investors awaited the release of the March Personal Consumption Expenditures (PCE) Price Index. Thanks to the after-hours surge in Alphabet and Microsoft shares following their earnings announcements the previous day, the market sentiment was positive at the start of trading. However, investors remained on edge about the price index set to be released at 8:30 AM.

Wall Street had predicted that the core PCE index for March would rise 0.25–0.28% from the previous month, based on the already released Consumer Price Index (CPI) and Producer Price Index (PPI) data for the same month. However, the first-quarter GDP report released the day before revealed that the core PCE index for Q1 had reached a staggering 3.7% year-on-year, catching market participants off guard. Considering that the index had risen 0.45% in January and 0.26% in February, there were concerns that it could jump as high as 0.48% in March.

Nevertheless, upon closer examination of the CPI and PPI components, such a high figure seemed unrealistic. As a result, Goldman Sachs and Bank of America scrambled to revise their predictions. Both banks indicated that the January and February numbers would be revised upward, and March would see a 0.33% increase. Although the market did not fluctuate significantly, the unease about higher-than-expected inflation numbers did not completely dissipate.

March PCE Index in Line with Expectations, Yet Concerns Linger

Fortunately, the March PCE index landed within the market’s expected range. The headline index rose 0.3% from the previous month and 2.7% year-on-year, while the core index increased 0.3% and 2.8%, respectively, matching February’s levels.

As anticipated, the core index for January was slightly revised upward from 0.45% to 0.50%, and February’s figure was adjusted from 0.26% to 0.27%. The March number came in at 0.32%. Nick Timiraos of The Wall Street Journal commented, “Much of the first-quarter inflation surge was due to the upward revision of the January figure. The March number wasn’t extraordinarily high.”

However, there were still some worrisome indicators. The year-on-year core index for the past three months accelerated from 3.7% in February to 4.4% in March, and the six-month year-on-year rate remained elevated at 3%. Notably, the “supercore” inflation rate, which excludes housing costs and is closely watched by the Fed, rose 0.4% month-on-month and reached 5.5% on a three-month annualized basis.

These figures make it challenging for the Fed to gain “confidence” in bringing inflation under control. Frederick Ducrozet of Pictet Wealth Management remarked, “While the numbers weren’t as bad as feared, they will likely tilt next week’s FOMC meeting in a hawkish direction and cast doubt on early rate cuts.”

Rate Cut Timing Pushed Back, Mixed Reactions in Long and Short-term Yields

Following the release of the March inflation data, Citigroup pushed back its forecast for the first rate cut this year from June to July and reduced its predicted number of cuts from five to four. In the Chicago Mercantile Exchange’s federal funds futures market, the odds of a September rate cut remained largely unchanged at 58.1%, compared to 58% the previous day.

Market reactions to interest rates were mixed. The yield on the 10-year Treasury note fell 4.3 basis points to 4.663%, while the yield on the 2-year note held steady at 4.998%, the same level as the previous day. Although Wall Street seemed relieved by the PCE index release itself, it appears that investors are not yet convinced about the prospects of rate cuts.

Wells Fargo noted, “The fact that inflation did not accelerate in the latter part of the quarter is positive, but the jump in the service price growth rate to 5.5% year-on-year could provide a rationale for the Fed to maintain its tightening stance.” The bank added, “Unless robust growth and consumption fuel inflationary pressures, it shouldn’t pose a significant threat to the Fed.”

Evercore ISI analyzed, “In light of this report, the Fed is likely to maintain a wait-and-see approach until it can establish a clearer direction.” The firm suggested that if the monthly core index slows to around 0.2% in the coming months, the chances of a rate cut in July or September would increase. However, if that doesn’t happen, the rate cut could be delayed until the fourth quarter or even be skipped altogether this year. Nonetheless, the possibility of additional rate hikes is still considered very low.

Inflation Vigilance in April Michigan Consumer Sentiment Index

Meanwhile, the final April reading of the University of Michigan Consumer Sentiment Index, released at 10 AM, also reflected heightened vigilance against inflation. The index fell to 76 from 77.4 in March, but what particularly drew attention was the trend in inflation expectations.

The one-year inflation expectation rose to 3.2%, exceeding both the preliminary reading (3.1%) and the March figure (2.9%), marking a four-month high. The five-year expectation also climbed to 3.0%, unchanged from the preliminary reading but surpassing March’s 2.8%. It entered the 3% range for the first time in five months since November last year (3.2%). The recent surge in gasoline prices seems to have played a role.

Ned Davis Research pointed out, “The rise in short- and long-term inflation expectations above pre-pandemic levels could provide grounds for the Fed to delay rate cuts.” The New York Fed’s inflation forecasting model also predicted an uptick from 2.23% in the first quarter to 2.7% in the second quarter.

In the end, the March PCE index concluded within the anticipated range, providing the market with a temporary sense of relief. However, long-term risk factors that could hinder the Fed’s early rate cuts remain, such as the stubbornly high “supercore” index, resilient demand and consumption despite the economic slowdown, and persistent consumer inflation expectations.

Until the Fed gains confidence in price stability, it will likely have no choice but to maintain a cautious stance while closely monitoring inflation indicators over the next few months. For the market, although near-term uncertainties have somewhat eased, it will be necessary to carefully assess the trajectory of the economic slowdown and inflation moderation while formulating a long-term outlook.

Strong Earnings and AI Investments by Alphabet and Microsoft

The New York stock market opened higher on April 26, buoyed by the earnings announcements of major companies. In particular, Alphabet and Microsoft led the market as they unveiled plans to ramp up AI-related investments on the back of robust earnings.

Wall Street heaped praise on both companies. Many investment banks raised their target stock prices for the two tech giants, with some suggesting levels above $200 for Alphabet. Microsoft also saw target prices approaching $500, reflecting the market’s high expectations.

What stood out the most was their strong commitment to AI investments. Alphabet and Microsoft, along with Meta, are making substantial AI investments. In the first quarter alone, they invested $12 billion (up 91% year-on-year) and $14 billion (up 21% year-on-year), respectively. This aggressive investment stance is expected to continue going forward.

However, there were also differences compared to Meta. While Meta hinted at the possibility of its future revenue growth rate falling short of expectations due to AI investments, Alphabet and Microsoft are already delivering tangible results. For instance, Microsoft’s Azure cloud service revenue grew 31%, and Alphabet’s Google Cloud business saw a 27% increase.

Securities analysts suggested that Alphabet could expand profits by enhancing its AI-powered search services. As for Microsoft, they assessed that the growth of its AI-driven cloud services justifies the expansion of capital expenditures. Bolstered by these positive factors, Alphabet shares skyrocketed by more than 10%, and Microsoft shares also rose by about 2%.

Expectations for AI Investment Benefits and Semiconductor Industry Outlook

The expansion of AI investments by tech giants such as Alphabet and Microsoft fueled expectations for related industries, especially the semiconductor sector. Major semiconductor companies like NVIDIA and AMD saw strong performances across the board, with some stocks surging more than 6%.

Bank of America, in a report titled “In AI We Trust,” forecasted that capital expenditures for cloud services would increase significantly. The bank estimated that spending would reach $220 billion in 2024, up more than 35% from the previous year, which bodes well for data centers and the semiconductor industry.

In particular, Bank of America recommended buying NVIDIA, Broadcom, Marvell, AMD, and Micron, citing them as the top five semiconductor companies expected to benefit from AI investments. The bank predicted that these companies would enjoy advantages as the AI infrastructure buildout cycle continues for the next 3–4 years.

However, Intel’s sluggish performance emerged as a variable. Although its first-quarter earnings met expectations, the company’s stock plunged more than 9% as its second-quarter guidance fell significantly short of market projections. Improving technological prowess and restructuring costs are among the many challenges Intel faces, according to securities firms.

Stock Market Rally and Investor Caution

Driven by the strong performance of the high-tech and semiconductor sectors, major indices in the New York stock market closed higher across the board. The S&P 500 rose 1.02%, the Nasdaq Composite gained 2.03%, and the Dow Jones Industrial Average advanced 0.40%.

However, as the indices have been rising rapidly, a wait-and-see approach is spreading among investors. Concerns about technical overbought conditions due to the short-term surge have begun to emerge, especially for Alphabet shares.

Meanwhile, Tesla shares closed about 1% lower, seemingly affected by reports that CEO Elon Musk is seeking funding for the establishment of a new AI-related company called “xAI.” Renowned investor Mark Minervini added Micron to his list of recommended stocks, anticipating benefits from the AI-related market, exemplifying the shift of investment money toward AI-related stocks.

Overall, the bullish sentiment in the New York stock market, driven by strong first-quarter earnings and growing expectations for AI investment, is likely to persist for the time being. However, as the pace of stock price increases accelerates, investor risk awareness is also gradually heightening. It seems necessary to carefully assess corporate earnings, the macro environment, and the momentum of AI investments.

Inflation Concerns vs. Strong Corporate Earnings

Recently, concerns about inflation have been resurfacing in the market. This is due to the persistently high levels of the March PCE Price Index, which has dampened expectations for the Fed’s early rate cuts. Nevertheless, it is also true that robust corporate earnings are alleviating these inflation concerns and supporting the stock market rally.

According to FactSet, 46% of the S&P 500 companies have reported their first-quarter earnings so far, and 77% of them have recorded earnings per share (EPS) above analyst expectations. This matches the 5-year average (77%) and exceeds the 10-year average (74%), indicating a favorable trend. On average, companies’ EPS have surpassed the market consensus by 8.4%, slightly below the 5-year average (8.5%) but above the 10-year average (6.7%).

Moreover, resilient personal consumption also seems to be functioning as a factor underpinning the economy. Retail sales in March increased by 0.8% month-on-month, beating market expectations, while the core retail sales excluding automobiles also rose by 1.1%, indicating a continued expansion in consumption.

Amid this backdrop, some argue that if the economy can maintain its current pace, a delay in the timing of rate cuts may not be an issue even if inflation runs slightly higher. Bruce Kasman, Chief Economist at JPMorgan, presented two scenarios: (1) a “boil the frog” case where high interest rates become a drag on corporate earnings, and (2) a “new normal” case where the economy can withstand high interest rates. Kasman noted, “The current economy has elements of both scenarios,” but also acknowledged that “it’s premature to determine which way it will lean.”

However, if core inflation remains stubbornly high in the mid-3% range, it could become a long-term burden on the economy. Neil Dutta, Chief Economist at Renaissance Macro, warns, “Persistent inflation could lead to a decline in real incomes, potentially squeezing consumption and corporate profits. This would be negative for the stock market.”

The recent rapid appreciation of the U.S. dollar also has the potential to be a headwind for companies with high overseas revenue ratios. In fact, the ICE U.S. Dollar Index rose 0.47% to 106.09 points on April 26, reaching its highest level against the Japanese yen since 1990. The yen’s depreciation against the dollar is accelerating as the Bank of Japan maintains its accommodative monetary policy stance. This can be attributed to the persistent high inflation in the U.S. and the expectation that interest rate hikes will continue for an extended period.

Three Key Events to Watch

Three critical events that could influence the market’s direction are scheduled for the coming week.

The first is the first-quarter earnings announcements by Amazon and Apple. The market is focusing on the growth rate of Amazon’s cloud service, AWS, and the extent to which Apple’s flagship iPhone sales slump will weigh on its performance. Given that Alphabet and Microsoft delivered strong numbers in their cloud businesses, the performance of industry leader AWS will be crucial in gauging future prospects. For Apple, which is rumored to have seen a decline in iPhone shipments, the key will be whether other businesses can pick up the slack.

Additionally, the earnings results of Super Micro Computer, which postponed its announcement last week, are also drawing attention. The company’s stock plummeted more than 20% just before the scheduled earnings release, facing headwinds, so there is keen interest in how much ground it can regain with this announcement.

The second event is the outcome of the Federal Open Market Committee (FOMC) meeting on May 1. The market widely expects the Fed to maintain the current target range of 1.75–2.00%. However, Chair Jerome Powell is likely to reiterate the Fed’s vigilance against high inflation and signal its intention to keep policy rates elevated for the time being.

Brian Nick, Chief Strategist at Macro Research, points out, “Judging from the recent public comments by Fed officials, the hawkish stance seems to be gaining the upper hand.” He anticipates that Powell’s press conference will also emphasize inflation risks.

Furthermore, the upcoming meeting may also reveal plans to adjust the pace of balance sheet reduction (quantitative tightening, or QT). Wells Fargo notes, “The Fed is currently absorbing $60 billion per month from the market by not reinvesting the proceeds from maturing Treasuries and other securities. It appears to be considering the option of halving this pace.” The specific announcement may be made at this meeting or postponed until June.

The third event is the release of the April employment report. The market expects nonfarm payrolls to increase by 250,000 from the previous month, a slight deceleration from the March figure (up 303,000) but still a high level of growth.

In this regard, Morgan Stanley suggests that the large-scale immigrant inflow last year may have altered the dynamics of the job market. The bank explains, “With net immigration reaching 3.3 million last year, the monthly payroll growth needed to maintain a stable unemployment rate might have been raised from 100,000 to around 265,000.”

Along with the employment data, the April ISM Manufacturing and Services PMI and the first-quarter Employment Cost Index (ECI) are also scheduled for release. The flash readings of the S&P Global PMI for April, released earlier, indicated a slump in both the manufacturing and service sectors, falling below the 50-point threshold. It will be interesting to see if the ISM figures exhibit a similar trend. The market may also look for signs of easing wage pressures through the ECI.

To sum up, despite the strong corporate earnings, uncertainties in the market persist due to variables such as inflation concerns, the risk of economic slowdown, and the ongoing dollar strength. The FOMC meeting and employment data, in particular, are important events that will provide clues about the Fed’s monetary policy direction, likely attracting investor attention.

However, considering that we are in the midst of the corporate earnings season, it is essential to keep an eye on individual companies’ performance trends, not just from a macro perspective. The market will need to make judgments based on both the fundamentals of an economy facing inflation and monetary tightening, and the micro-level strengths of individual companies supported by themes such as AI investments.