In volatile week, stocks close lower on rising inflation fears

Every portfolio benefits from bonds; they provide a cushion when the stock market hits a rough patch. But avoiding stocks completely could mean your investments won’t grow any faster than the rate of inflation. – Suze Orman

Volatility returned to the stock market last week with all three major stock averages closing lower after the consumer price index (CPI) in April soared, raising inflation fears. The technology-heavy Nasdaq Composite Index was the biggest loser with a loss of 2.3% as investors took profits in the big tech stocks that had been the winners throughout the pandemic. Although the selling started early in the week, it cascaded on Wednesday when the April consumer price index (CPI) jumped nearly 1%, four times higher than expected. The biggest culprit was energy prices, which surged 25% from a year earlier. The year-over-year increase was 4.2% and it was the highest inflation reading in 13 years, prompting fears that the Federal Reserve may have to raise interest rates sooner than expected. At this time last year, inflation was almost non-existent as the Covid-19 pandemic caused a widespread shutdown of the economy. Higher inflation was particularly noticeable in the transportation and travel industries as the prices of airline tickets, hotels and used cars surged. In the coming months, there will be substantial uncertainty around the path of inflation and other economic data, especially with the Federal Reserve holding interest rates near zero and additional fiscal stimulus on the way in the form of infrastructure and family assistance bills. But the Fed remains steadfast in its view that inflation will be transitory and settle down around 2% later this year. Massive fiscal stimulus and improving public health with the rollout of vaccines has created a surge in demand that is pushing against supply constraints, resulting in increased inflation. However, as the supply side of the economy catches up to the demand side, this spike in inflation should begin to wane and price increases should be more modest.

Last Week

The producer price index (PPI) in April was also much higher than expected and registered the biggest increase since the Bureau of Labor Statistics began tracking the data in 2010. The core PPI, which excludes food and energy, was up nearly 5% year-over-year. Retail sales in April were unchanged after soaring in March but are expected to pick up in coming months amid excess savings accumulated by consumers during the pandemic and a reopening economy. Weekly jobless claims totaled 473,000 compared to the forecast of 490,000 and were less than in the prior week. The University of Michigan consumer sentiment index for early May was much less than anticipated due to inflation worries.  Job openings jumped to over 8 million in April as employers struggled to find workers to fill these positions.

For the week, the Dow Jones Industrial Average fell 1.1% to close at 34,382 while the S&P 500 Index declined 1.4% to close at 4,173. The Nasdaq Composite Index lost 2.3% to close at 13,429.

This Week

Housing starts and existing home sales for April are both expected to be slightly less than in March but still at a high level. Leading economic indicators in April is forecast to increase over 1% but be less than the gain last month as the economy continues to reopen with fewer restrictions. The Federal Open Market Committee (FOMC) releases minutes from its monetary policy meeting in April.

Among the most notable companies scheduled to report first quarter earnings this week are Home Depot, Lowe’s, Walmart, Target, Macy’s, Kohl’s, TJX Cos., L Brands, Cisco Systems, Analog Devices, Applied Materials, Palo Alto Networks and Deere.

Portfolio Strategy

Although the inflation data released last week was much higher than expected, one positive for the markets and the economy was the announcement from the Centers for Disease Control & Prevention (CDC) that eased Covid-19 guidelines. In most places, fully vaccinated people no longer will be required to wear masks either indoors or outdoors. The number of coronavirus cases is also declining rapidly which should pave the way for a strong economic reopening. But after April’s hotter than forecast producer price index (PPI) and consumer price index (CPI) data last week, a stronger economy could rekindle inflation fears and lead to higher interest rates. The reaction of the 10-year Treasury yield to the surge in prices was muted as the yield ended the week at only 1.63%. Investors will be closely watching the minutes from the most recent Federal Reserve meeting this week to get clues about possible changes to the Fed’s monetary policy. It has repeatedly maintained that the federal funds rate will not increase until 2023 at the earliest and that it will continue with its $120 billion a month bond buying program for the foreseeable future. The soaring inflation data as well as the much weaker than expected April employment report in which only 266,000 new jobs were created when 1 million were forecast could just be one-offs and dismissed by the Fed as being an aberration. After all, the Fed seems convinced that the spike in inflation is transitory and will subside as the year progresses. However, the trend in inflation over the next few months bears watching as investors may have legitimate concerns that it may not be temporary and interest rates could head higher as a result.