Stocks gain on favorable CPI data, better than expected bank earnings

So smile when you read a headline that says ‘Investors lose as market falls.’ Edit it in your mind to ‘Disinvestors lose as market falls – but investors gain.’ Though writers often forget this truism, there is a buyer for every seller and what hurts one necessarily helps the other. – Warren Buffett 

There were a lot of potential land mines last week that could have had negative consequences for the stock market, but the major averages managed to avoid them and closed modestly higher. The biggest winner was the Dow Jones Industrial Average with a gain of 1.2% while the technology-heavy Nasdaq Composite Index only added a third of one percent. Investors received good news on inflation as the March consumer price index (CPI) edged only slightly higher for the month and was up 5% from a year ago, both below estimates. While the core CPI that excludes food and energy prices was in line with expectations, the headline annual increase for the CPI was the smallest gain since June 2021. Inflation is showing continuing signs of decelerating and a slowing economy should bring inflation closer to the Federal Reserve’s long-term target of 2%. In fact, the Fed minutes from the March monetary policy meeting showed that Fed officials were concerned that the U.S. banking crisis could tip the economy into a recession later this year. They expect GDP growth to be less than one percent in 2023 but emphasized that more needs to be done to combat inflation. Despite the expectation of tighter lending standards and deteriorating credit conditions brought on by the banking crisis, the Fed is likely to increase the federal funds rate one more time by 25 basis points (a basis point is one hundredth of one percent) in May to a level of 5.0% to 5.25% and then pause. The markets, on the other hand, are predicting the same hike in May but are forecasting that the Fed will be cutting rates by year-end. The last hurdle for the markets came on Friday with the beginning of the first quarter earnings season that was led by the big money center banks. After the collapse of Silicon Valley Bank and Signature Bank in March, investors were fearful that bank earnings would be disappointing and that earnings guidance for the rest of the year would be lowered. But three of the biggest U.S. banks reported results that topped analysts’ estimates and assured investors that they are well-positioned to deal with the headwinds facing the industry.

Last Week

The March producer price index (PPI) fell and was better than anticipated, registering the first negative reading since April 2020. On an annual basis, wholesale prices rose 2.7%, which was also better than forecast. March retail sales fell by 1%, worse than expected and more evidence that the economy is slowing as consumers grapple with high interest rates and the impact of high inflation. Much of the decline in sales, though, was due to lower gas prices, which is actually a slight positive for spending. Weekly jobless claims rose by 11,000 to 239,000, the highest level in more than a year. The University of Michigan consumer sentiment index rose in April from the March reading and was better than expected.

For the week, the Dow Jones Industrial Average rose 1.2% to close at 33,886 while the S&P 500 Index gained 0.8% to close at 4,137. The Nasdaq Composite Index added 0.3% to close at 12,123.

This Week

March housing starts and existing home sales are both forecast to be less than in February, although existing home sales in February recorded their biggest increase since July 2020. The Leading Economic Index for March is expected to decline again for the 12^th consecutive month.

Among the most notable companies scheduled to report first quarter earnings this week are Netflix, IBM, Tesla, Charles Schwab, State Street, Bank of America, Goldman Sachs, Morgan Stanley, U.S. Bancorp, American Express, Travelers, Johnson & Johnson, Abbott Labs, Lockheed Martin, CSX, Union Pacific, Baker Hughes, Schlumberger, AT&T and Procter & Gamble.

Portfolio Strategy

While three of the country’s biggest money center banks kicked off the first quarter earnings season with positive results last week, the next few weeks will be more indicative of the overall health of the banking industry as small and medium-size banks report their earnings. These financial institutions are more vulnerable to deposit outflows and liquidity issues than the big banks, which saw an increase in deposits after the collapse of Silicon Valley Bank and Signature Bank. JP Morgan Chase began the earnings parade last week with record first quarter revenue and profits as net interest income surged nearly 50% from a year ago on higher rates and the bank also raised guidance for net interest income for the year. Citigroup and Wells Fargo followed by reporting revenue and earnings that also topped expectations as both banks benefited from higher interest rates. But many small and mid-size banks are trading below their book value as investors fear that the banking crisis in March may have affected their balance sheets and liquidity and could lead to greater deposit outflows and negatively impact future profitability. These banks may also be forced to raise the interest rates that they pay on deposits in order to keep them, lowering their net interest margins and profits. With fewer deposits, banks may have to reduce the amount of money they can lend and be more selective in their lending standards to potential borrowers. These questions should all be answered in the next few weeks as these regional banks report their quarterly earnings and give investors guidance for the balance of the year.