The Slugfest for Market Sentiment: Inflation vs Profits

As companies this earnings season generally announce stellar results and outperform expectations, investors find themselves buoyed by optimism. However, this enthusiasm is tempered by the specter of elevated inflation.

First, let’s look at the latest inflation data. The producer price index (PPI) for April was released by the U.S Bureau of Labor Statistics (BLS) on Tuesday and it came in a bit warm. The PPI, which measures wholesale prices, was 2.2% for the 12 months ended in April, a gain that’s higher than the 1.8% witnessed in March.

But better inflation news arrived Wednesday, when the BLS reported that the consumer price index (CPI) eased in April, providing a modicum of relief for consumers although still holding above levels that don’t augur an imminent interest rate cut.

The CPI rose 0.3% from March, slightly below the consensus estimate for 0.4%. On a 12-month basis, the CPI increased 3.4%, in line with expectations.

Excluding the volatile components of food and energy, the ”core” inflation reading came in at 0.3% monthly and 3.6% on an annual basis, both as forecast. The core 12-month inflation reading was the lowest since April 2021; the monthly increase was the smallest since December (see chart).

The latest CPI report was positive news, but until we get a clearer indication that inflation is on a steady long-term decline, inflation readings will continue to whipsaw the markets. Investors will be on edge in advance of every inflation report.

Earnings momentum bolsters market sentiment…

In a financial world where each economic data point is meticulously scrutinized for its implications on Federal Reserve policy, the fundamental driver of long-term market returns—corporate profits—often remains in the shadows.

However, the market’s upward trajectory over the past three weeks has been propelled by a robust earnings season that aligns perfectly with the rally, signaling ongoing economic expansion and profit growth.

About 92% of S&P 500 companies have reported first quarter 2024 earnings so far. Profitability has rebounded, shedding the pressures experienced throughout 2022 and part of 2023, with input-cost inflation now showing signs of moderation.

First quarter outcomes for the S&P 500, coupled with promising company guidance, have bolstered confidence in the trajectory of full-year earnings, which are expected to surpass year-over-year growth of 10%, according to FactSet.

Historically, analysts tend to pare back their optimistic initial earnings projections by approximately 4% over the course of a year (that’s the averaged since 1994). Surprisingly, in 2024, earnings revisions have defied this norm, remaining steady despite concerns surrounding inflation, interest rates and economic conditions.

Companies that have reported positive earnings surprises for Q1 have witnessed an average price increase of +0.9% two days before the earnings release through two days after the earnings release. Conversely, companies that have reported negative Q1 earnings surprises have seen an average price decrease of -2.8% two days before release through two days after.

As we approach the end of the first quarter earnings season, here are key insights:

  • Big Tech’s investment in artificial intelligence (AI) is accelerating.
  • Analysts foresee earnings growth expanding beyond Big Tech, which bodes well for markets.
  • Consumer spending remains robust, despite initial concerns about consumer fatigue.
  • Companies have provided better-than-expected guidance, defying typical patterns.

Stock prices are hovering close to all-time highs, standing approximately 8% above the previous peak of the bull market in early 2022, mirroring the growth in earnings.

The upshot: Despite uncertainty regarding the Fed’s future policies and concerns about the raucous U.S. presidential election, the strong growth of corporate earnings continues to bolster market advances. Corporate profitability is winning the fight for investor sentiment.

The main U.S. stock market indices closed sharply higher Wednesday as follows:

  • DJIA: +0.88%
  • S&P 500: +1.17%
  • NASDAQ: +1.40%
  • Russelll 2000: +1.14%

The S&P 500 posted its 23rd record in 2024, topping 5,300 for the first time. The benchmark 30-year U.S. Treasury yield fell 1.70% to settle at 4.51%.

Read This Story: The Stubborn Bulls Defy The Naysayers

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John Persinos is the editorial director of Investing Daily.

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