Markets React: Equities Slide, CPI Surprises, Data Slows

Key takeaways:

• Equity markets fell for the second week, marking a temporary pause following the solid start for the year.
• CPI surprised to the upside, reminding investors that the normalization to 2% is not a straight line.
• Economic data is beginning to slow, with falling consumer sentiment and small business confidence.

Drivers of market movement

Equity markets paused following a strong and steady run, with the S&P 500® Index falling for the fourth week in six. Bulls and bears are increasingly in a tug of war, with bulls focused on the soft landing, and bears on inflation, rates, and Fed hawkishness. Geopolitical tension between Israel and Iran intensified this week, causing the VIX to jump to the highest level since November. Daily volatility has jumped, with nine consecutive sessions alternating between gains and losses, though the S&P 500 is unchanged over the past month. Despite the nervous tenor of markets, the relative resilience of equity markets in the face of a wave of nerve-racking data is impressive, with the S&P 500 less than 3% below a record high.

Bond markets are again trading with volatility normally reserved for equity markets, with rates surging this week on a hot CPI reading and a weak 10-year auction. The 10-year Treasury yield jumped 0.11% to 4.51%, after briefly touching 4.60% for the first time since September. The yield has jumped 0.63% this year, while the 2-year jumped a similar 0.63% to 4.88%. The short end of the curve has seen the most dramatic move, with the number of cuts priced into the Fed Futures curve this year down below two, with the first cut not expected until September, compared with more than six cuts priced in at the beginning of the year, with the first cut in March. Since October, despite interest rates and inflation data, equity markets have been noticeably immune to fluctuations, but reactions are becoming more intense as the market flattens. This market dynamic challenges consumer spending, corporate profits, and the Federal deficit.

Wednesday’s report on CPI served as a reminder that inflation normalization isn’t a straight line, with headline CPI up a hotter-than-expected 0.4% from February and 3.5% from a year ago, the fastest pace since September. Excluding food and energy, core CPI rose 0.4% sequentially and 3.8% from a year ago. Compared with a year ago, the greatest pressure was seen in transportation (+11%), shelter (+5%), electricity (+5%), and food (+4%). Inflationary pressure is intense when viewed over the past three years, with gasoline up 24%, food up 21%, shelter up 20%, and cars up 20%, compared with wage growth of just 15%. The pressure in March was broad-based, with the Atlanta Fed’s reading on “sticky inflation” (a weighted basket of items that change price relatively slowly) up 4.5% from a year ago, while “flexible inflation” at an 11-month high at 0.8%. Inflation expectations have surged, with the 1-year breakeven inflation rate (derived from TIPS) at 4.4% (the highest level since June 2022) and the 2-year at 2.9%.

Friday was the unofficial launch of earnings season, highlighted by reports from several large banks, including JPMorgan, Citigroup, State Street, and Wells Fargo. JPMorgan CEO Jamie Dimon made headlines when he noted that “persistent” inflation, “terrible wars and violence,” and the Fed’s efforts to tighten financial conditions threaten an otherwise positive economic backdrop. “Looking ahead, we remain alert to a number of significant uncertain forces,” he said in the earnings release. Analysts were disappointed by the banks’ management due to a lack of guidance, particularly on net interest margins. Earnings growth is forecast at 3% for the quarter.

Economic data is mixed, with notable disappointments in confidence metrics this week. The NFIB Small Business Index hit the lowest level in 11 years in reaction to inflation, interest rates, and labor market challenges, marking the 27th consecutive month with the index below the historical average. Respondents noted a slowdown in demand, with additional concerns over input costs and the availability of capital. The University of Michigan’s Consumer Sentiment fell more than expected to 77.9, impacted by surging energy prices and borrowing costs. The percentage of consumers blaming high prices for impacting living standards is 39% from 33% last month. Pressure on the consumer is also extends to the housing market. In April 2024 the monthly mortgage payment needed to buy the median-priced home was $2,750, nearly double the level from April 2020 at $1,480.

Details on performance

Domestic markets were lower this week, driven by a sharp decline on Friday in reaction to bank earnings releases. The S&P 500 has lost in back-to-back weeks, dropping 2%, while the NASDAQ fell fractionally and the Dow lost 2%. Growth indexes beat value, while large caps beat small caps. Leading sectors for the week included communication services, technology, and consumer discretionary, while financials, health care, and materials lagged. Volatility jumped, with the VIX closing above 18 for the first week since October. Trade volume was light.

Global markets fell in sympathy with the downturn seen in domestic markets, with the performance of the MSCI EAFE® Index and MSCI Emerging Markets® Index roughly in line with the S&P 500. Asian markets were weak on sluggish export data from China, leading to a 5% drop in South Korea, a 3% loss in Hong Kong, and a 1% decline in China and Japan. Europe was lower despite dovish commentary from the ECB and encouraging economic data in the UK, as Spain, Germany, Italy, and France each lost 3%. Latin America fell on the surge in domestic rates, with Mexico down 4% and Brazil down 1%. The trade-weighted dollar Index gained 1% on the surge in interest rates, now gaining 5% for the year.

Bond yields jumped this week in reaction to the CPI print, with the 10-year yield jumping 0.11% to 4.51%. The 2-year yield rose 0.13% to 4.88%, resulting in a modest further inversion of the yield curve. Global rates were higher, while credit spreads were little changed. Commodity prices eased modestly, with the S&P Goldman Sachs Commodity Index down fractionally for the week but remains up 12% for the year. Crude prices fell 1% despite rising tensions in the Middle East. Precious metals surged on the inflation report, while agricultural commodities were mixed.

The choppy equity market is sending some investors to the sidelines, with $20 billion in outflows in the latest week, the second largest of the year. Despite this, domestic equity funds are on pace for $231 billion of inflows for the year per Bank of America, the second-biggest year on record. Global bond funds continued to attract flows, adding $13 billion for the week, with Treasuries bringing in assets for the ninth straight week. Money market funds had a rare flat week, as cash funds are on pace to bring in $1 trillion this year. Sentiment indicators weakened materially this week, with the CNN Fear & Greed Index falling to 48 on a scale from 0-100 from 62 last week, below neutral for the first time since last November. The AAII Sentiment Survey saw bulls fall to 42% from 47% last week.

What to watch

Earnings will be the primary focus of investors next week as the number of reports accelerates. Economic data include retail sales on Monday, housing starts and industrial production on Tuesday, the Fed’s beige book on Wednesday, and existing home sales and leading indicators on Thursday.