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Why the stock market is not impressed with the first monthly decline in consumer prices in more than 2 years


Inflation data may not be as big a catalyst for stocks as it once was.

US stocks bounced to a higher close on Thursday, although investors received some encouraging inflation news following the consumer price index. for December shows the first monthly decline since the pandemic swept the globe in 2020.

Considering that inflation has been one of the most consequential issues for the market over the past year, investors may have expected stocks to rise.

Instead, after the previous waiver, the stock ended Thursday with modest gains, the magnitude of which is much smaller than in recent days of CPI announcements.

While the monthly CPI fell 0.1% in December, the annualized index fell for the sixth straight month to 6.5% from 7.1%. That was the lowest level in more than a year and down from a 40-year high of 9.1% last summer.

To better understand what has led to such a muted reaction to stocks, despite the key economic milestone, MarketWatch has gathered insights from market strategists on what happened. go out.

‘The number whispers’

Perhaps the main reason stocks greeted the CPI data with disappointment is that investors have been anticipating a further drop in inflation. Some are even hoping that the drop will be large enough to prompt the Federal Reserve to reconsider raising interest rates more.

Prior to the October and November CPI data, economists had really underestimated the magnitude of the drop in price pressures year-over-year. And as prices for commodities such as used cars, oil and other commodities fell late last year, traders predicted they might be too cautious again in December.

As a result, a “whispering figure” shared among market experts suggests that core inflation – which is the Fed’s main focus – will slow even faster than economists expect. economy, according to Bill Sterling, global strategist at GW&K Investment Management.

Instead, the core level, which excludes volatile food and energy prices, rose 0.3 percent, in line with the median forecast from economists polled by The Wall Street Journal.

Options traders were too optimistic

According to Charlie McElligott, managing director of cross-asset strategy at Nomura, who compiled data on options flows in a note shared with clients and reporters, options traders have bet that Stocks will rise in recent weeks as CPI data is coming out.

Just before the data was released, McElligott said the stock could be “disappointing” if the data comes out “just right” with expectations.

Traders are increasingly using options to trade CPI reports and other closely watched data releases, like MarketWatch reported.

Needle not moving report

Several market commentators noted after the CPI report that the data did not fundamentally change expectations about where rates will peak or how quickly the Fed will move from raising rates to cutting rates. any.

Following the report, interest rate futures traders bet on the possibility that the Fed will slow the pace of rate hikes by 25 basis points in March. Although they had previously seen such a move as very likely, now they consider it a virtual certainty.

But expectations for when the Fed might start cutting rates were relatively flat, with traders continuing to expect the first cut to happen in the fall.

Perhaps the biggest reason for this, according to Sterling, is that the Fed wants to see wage inflation drop significantly before it’s satisfied.

Signs of slowing wage growth in December helped inspire 700 points increase for the Dow Jones Industrial Average when its monthly labor market report is released last Friday. The report found that year-over-year average hourly earnings growth slowed to 4.6% in December from 4.8% in November. But the markets have already priced in this, the strategies strategist said.

And while equity valuations are certainly better than wage increases, Sterling points out that the Atlanta Fed’s wage tracker is still performing at 6.4% year-over-year. That would need to be reduced significantly to please the Fed, he said.

“The Fed needs to see wage growth drop to close to 3% to believe its job done,” Sterling said.

See: Why a stock market obsessed with the Fed’s inflation war should focus on Main Street jobs in 2023

Pricing is still too high

Finally, while lower inflation tends to benefit stock valuations, stocks still appear to be overvalued based on previous periods of high inflation, said Greg Stanek, a manager portfolio manager at Gilman Hill Asset Management, said.

“The market loves when inflation goes down, which means higher multiples,” said Stanek. “However, inflation is at 6.5%. That number is still too high to justify paying 17x to the market.”

The S&P 500 futures price-earnings ratio was 17.3 as of Wednesday’s close. compared to the recent peak north of 24 in September 2020, according to FactSet data.

Over the past year, US stocks have shown a strong reaction to the CPI data. As the October CPI beat economists’ expectations for a modest drop, the S&P 500 5.5% increase in one day. That’s the biggest daily increase of the year in 2022.

Sure, the market tends to look ahead, as market strategists like to say, and there’s always the possibility that traders’ views on Thursday’s data could evolve over the days and weeks. next.

In a recent analysis, a Deutsche Bank strategist looked at the reaction of US stocks to inflation data released over the past two years. He noticed that the market reaction became more mixed as time went on.

Jim Reid, head of topical research at Deutsche Bank, said: “Although inflation rose higher than expected than expected over a two-year period, the performance was a bit more random than expected”. The note is released ahead of Thursday’s data.

BANK DEUTSCHE

“In April 2022, the downside miss in the March reading saw a -9% sell-off in the following month, while the same result for October 2022 data was published. announced in November saw a +7% increase after the data was released on November 10,” Reid said.

Stocks end modest gains on Thursday, with S&P 500
SPX,
+0.34%

rose 13.56 points, or 0.3%, to 3,983.17, while the Dow Jones Industrial Average
DIA,
+0.64%

up 216.96 points, or 0.6%, to 34,189.97 and the Nasdaq Composite
CALCULATOR,
+0.64%

up 69.43 points, or 0.6%, to 11,001.10.

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