by David Randall
NEW YORK (Reuters) – U.S. stock investors are turning their attention to next week’s inflation data, which could determine the near-term path of an equity rally that has faltered in recent weeks.
Signs that the U.S. economy is on its way to a so-called soft landing, where the Federal Reserve is able to reduce inflation without badly hurting growth, helped fuel the S&P 500’s 16% year-to-date gain .
Last week’s employment data played into that narrative, showing that the job market remains strong, though not strong enough to raise concerns that the Fed will need to raise interest rates further to fight inflation. There will be a need, which shook the market last year.
Investors said consumer price data next week may need to strike a similar balance. Much higher numbers could raise concerns about the Fed keeping interest rates high for longer or raising them further in the coming months. That would give investors less reason to hold onto shares after a tech-led decline in which the S&P 500 fell nearly 5% from summer highs.
“This inflation demon is far from gone,” said Michael Purves, head of Talbachan Capital Advisors, who expects signs of higher inflation to weigh on the multiples of megacap growth names that have driven the rally. “If structural changes are accompanied by GDP growth, it will come with some instability and unintended consequences.”
Investors trying to assess future Fed policy will also look to other data in the coming week, including readings from the producer price index and retail sales.
The US central bank is widely expected to keep benchmark rates steady at its September 20 meeting. Markets are also estimating about a 44% chance of the Fed raising rates at its November meeting, up from 28% a month ago.
“If we get a higher inflation print we will see those expectations move right up for September and November,” said Randy Frederick, managing director of trading and derivatives at the Schwab Center for Financial Research.
Optimistic, but cautious
Despite the recent fluctuations in stocks, strategists and investors remain largely confident in the market at the moment. However, some people are becoming more cautious.
Reasons for optimism include the relative outperformance of the U.S. economy compared to Europe and China, and signs the so-called profit slowdown among S&P 500 companies may be over.
Still, concerns about an economic slowdown in China and shrinking U.S. corporate margins have led some market participants to believe it will become more difficult to make big profits from stocks.
The S&P 500 information technology sector lost more than 2% this week after news that Beijing has ordered central government employees to stop using iPhones for work. Apple shares fell 6% during the week on fears the company and its suppliers could be hit by increased competition from China’s Huawei.
“We think we’re still in a bull market that will reach new highs before the end of the year, but it will be a bumpy road,” said Ed Clissold, chief U.S. strategist at Ned Davis Research.
The S&P 500 is down about 5% from its July high, which has made stock valuations broadly more attractive given the low likelihood of an imminent recession, said Jonathan Golub, senior equity strategist at Credit Suisse Securities.
He said forward price-to-earnings multiples declined for 10 of the S&P 500’s 11 sector groups in August, although the P/E for the index as a whole remains near 20, compared with 17 at year-end 2022. .
Still, much of the bullish case for stocks hinges on soft inflation ultimately prompting the Fed to lower interest rates.
“If we saw further increases in interest rates, the equity market would not take it well,” said David Lefkowitz, head of U.S. equities at UBS Global Wealth Management.
(Reporting by David Randall; Editing by Ira Iosebashvili and David Gregorio)