Markets stand firm amid inflation challenges and earnings surprises

Key takeaways:

• Equity markets rebounded from recent weakness, showing impressive resilience.
• Economic data reflected stubborn inflation and uncertain growth, though markets handled it in stride.
• Earnings were a major news driver this week, with mixed results for the high-profile reporters.

Drivers of market movement

Equity markets stabilized this week following a difficult period in April, gaining for the first time in four weeks. The S&P 500® Index is heading for a gain of over 2% despite a surge in potentially market-moving data. Thursday’s price action was interesting, with the S&P 500 falling more than 1.5% early in the day in reaction to a disappointing reading on first-quarter GDP that has some concerned with stagflation and some high-profile earnings misses, but rallied into the close for a loss of less than 0.5%. Similarly, a potentially disappointing inflation report on Friday was shrugged off by investors, with interest rates falling and equity markets rallying. Between October and March, the pendulum swing of optimism drove a steady move higher regardless of the news. April has seen a more “glass half empty” reaction, with good news again being treated as bad news. This week’s market fluctuations might hint at a subtle recalibration in investors’ sentiment and technical conditions.

Market performance this week was emblematic of how the market has become increasingly idiosyncratic. For example, the performance of the Magnificent 7 has acted as a market monolith over the past several years, with the group leading the market and demonstrating synchronized movements. However, this week proved that dispersion in performance and investor reactions to the Magnificent 7 is no longer uniform and that the group’s leadership is fading. For example, this week, Meta fell 11% due to earnings, while Alphabet (Google’s parent) surged 11% the day after releasing earnings. This year, Nvidia has gained 67%, Meta 25%, Amazon 14%, Alphabet 12%, and Microsoft 6% (in line with the S&P 500), while Apple has dropped 12%, and Tesla fell 32%.

Economic data this week reinforced the idea that stubborn inflation and healthy spending likely put the Fed on the sideline for the foreseeable future as it prepares for an FOMC meeting next week. Thursday’s GDP report showed disappointing growth of 1.6% versus the consensus estimate of 2.2%. Under the surface, however, the report showed encouraging consumer and business demand, offset by headwinds on trade. The inflation component of the report got investors’ attention, with the fastest pace of growth in a year. On Friday, the Bureau of Economic Analysis released the monthly report on personal income and spending, which includes the PCE deflator and the core PCE deflator (the inflation metric preferred by the Fed), rising a hotter-than-expected 2.7% (2.5% in February) and 2.8% (2.8% in February), respectively.

In reaction to this news, the market recalibrated expectations for Fed policy. The Fed Futures curve currently embeds less than 1.5 rate cuts this year, with the first not happening until November. By comparison, at the beginning of the year, the curve showed 6.3 cuts beginning in March, and the Fed’s dot plot from March showed three. The Bank of Japan voted to keep rates unchanged, driving the yen to a 34-year low, triggering BoJ officials to pledge to hike rates if the yen continues to fall. ECB Governing Council Member Panetta warned that a return to ultra-low interest rates may be required if cuts aren’t made soon.

This week marked the peak of earnings season, with solid earnings reports and guidance from several technology heavyweights helping to improve investors’ sentiment. With nearly half of the Index companies reporting, growth is trending towards 3%, consistent with expectations set at the beginning of the month. Net profit margins are indicated to improve from the fourth quarter, though it is very near the lowest level since 2020 as wage pressures, commodity costs, interest rates, and supply chain issues continue to be a challenge. Going forward, there are questions on whether companies still have the pricing power to maintain margins. The best margin expansion is seen in health care, energy, and materials, while technology, utilities, and communication services are contracting the most.

Details on performance

Domestic equity markets experienced a strong rebound from recent weakness, with the S&P 500® Index cutting the month-to-date loss in half with a 3% gain. The NASDAQ added 4%, while the Dow lagged with a 1% gain. Growth indexes solidly beat value, while small caps and large caps performed roughly in line. Leading sectors for the week included technology, consumer discretionary, and communication services, while energy, materials, and health care lagged. Volatility eased for the week, with the VIX back down to 15, while trading volume was elevated.

Global markets participated in the rally this week, with the MSCI EAFE® Index modestly lagging and the MSCI Emerging Markets® Index modestly leading the S&P 500 for the week and both leading for the month. Asian markets were higher, with China managing a 6% gain on a string of policy announcements, including the intention to increase stock purchases. South Korea gained 3%, while Japan lagged with a 1% gain. Europe was strong on the risk-on environment on encouraging earnings reports, with Spain and the UK adding 4%, Germany gaining 3%, and Italy and France rising 2%. Latin America was strong on higher energy prices, with Brazil and Mexico 3% higher. The trade-weighted dollar index was little changed for the week.

Long-term interest rates continued their steady move higher on stubborn inflation and shifting expectations on Fed policy, with the 10-year Treasury yield adding 0.05% to 4.67%, the highest weekly close since October. The 2-year fell 0.01% to 4.98% after briefly breaching 5%, with the spread between the two yields at the narrowest point of the year. Credit spreads eased modestly. Commodity prices rose modestly this week, with the S&P Goldman Sachs Commodity Index adding 1% this week and 12% this year. Crude prices rose 2%, snapping a two-week losing streak on lingering supply concerns in the Middle East. Precious metals fell sharply as tensions between Israel and Iran eased. Agricultural commodities were mixed.

Investor optimism rebounded subtly this week as markets have stabilized, with equity funds showing $4 billion of inflows into global equity funds, highlighted by $4 billion into domestic funds and $6 billion into Japan (largest since May 2013), offset by outflows in emerging markets. Bond funds saw $4 billion of inflows, the 18th straight positive week, driven by credit and offset by the first outflows from Treasuries in three months. Bank of America’s Bull & Bear Indicator crept to slightly above neutral at 5.1, helped by lower hedge fund short positions, resilient credit technicals, and lower cash levels. The CNN Fear & Greed Index rose to 42 from 32 a week ago but is still below neutral. The AAII Sentiment Survey saw a drop in bulls to 32% from 38%.

What to watch

Investor attention will shift to the Fed next week as earnings season slows. Economic releases include consumer confidence on Tuesday, USM and construction data on Wednesday, durable goods on Thursday, and the payroll report on Friday. The FOMC meeting concludes on Wednesday. Month-end positioning could add to volatility.