Weekly Market Update: August 22, 2022

The inflation narrative changed somewhat in the wake of the Labor Department’s July pricing reports. The Consumer Price Index came in lighter-than-expected on both a monthly and year-over-year basis, while the companion Producer Price Index (PPI) report showed even more easing in prices. The PPI or “wholesale index” unexpectedly fell 0.5% in July, and the 12-month gain of 9.8%, though still very strong, was below the consensus forecast.

The slightly tamer inflation data and resultant drop in Treasury market yields were greeted positively by Wall Street. In particular, the higher-growth technology and small-cap sectors were helped by the decline in fixed-income yields. That is because a lower discount rate, which is used to value future potential cash flows, increases the intrinsic value of companies and makes their stocks more appealing. The intrinsic value of a company is the present value of all expected future cash flows.

The ongoing debate is whether the July pricing data will serve as an inflection point for the Federal Reserve in its fight against inflation. Wall Street’s assessment of the probability of a less hawkish half-point hike to the benchmark short-term interest rate at the late-September Federal Open Market Committee (FOMC) meeting increased after the pricing data. That said, Federal Reserve officials have disputed the notion that the central bank will be less aggressive on the monetary policy tightening front through yearend. It should be noted that another round of inflation and employment data will be released before the next FOMC meeting.

Meantime, second-quarter earnings season was mostly supportive. With nearly 90% of the S&P companies having reported results, more than 70% of those entities delivered positive revenue and earnings surprises. However, the rub is that second-quarter results still mark the weakest showing since the final period of 2020 and second-half company prognostications have come down.

Conclusion: Equities got a boost from the moderation in July inflation data. The question is if what we’ve seen is what pundits call a bear market rally. We think that all the volatility is not behind us, and that investors should exercise some caution, as signs still point to a slowdown in economic growth and possibly a recession.

Source: Valueline.com