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Stock market’s winning streak ends as inflation surges

I can’t recall ever once having seen the name of a market timer on Forbes’ annual list of the richest people in the world. If it were truly possible to predict corrections, you’d think somebody would have made billions by doing it. – Peter Lynch

All good things eventually come to an end and last week was no exception as the major stock averages had their winning streak halted at five weeks with modest losses across the board. The S&P 500 Index dropped about a third of one percent as inflation data for October came in hotter than expected. On Tuesday, the October producer price index (PPI) was in line with estimates but has now increased 8.6% on a year-over-year basis, the highest annual increase in the last 11 years. Surging prices for gasoline and autos were responsible for much of the increase. As if that reading wasn’t bad enough, the consumer price index (CPI) released on Wednesday jumped more than expected with a year-over-year increase of 6.2%, the highest level since December 1990. Excluding volatile food and energy prices, core CPI rose 4.6%, the biggest gain since August 1991. The unexpected surge in inflation caused the yield on the 30-year U.S. Treasury auction to rise to 1.95%, raising fears that long-term interest rates might continue to increase and prompt the Federal Reserve to tighten sooner rather than later. While the market is predicting at least two Fed rate hikes in 2022, the Federal Reserve is just predicting one. It still believes that the recent spike in inflation caused by supply chain disruptions tied to the coronavirus pandemic will moderate next year and inflation will return to the Fed’s 2% target. While the bond market appears to be skeptical of this assessment of inflation, the stock market seems to be in agreement as losses last week were muted. Much of that positive sentiment has been due to strong corporate earnings that continue to impress investors and limit any downside for the stock market. Slightly over 90% of S&P 500 companies have reported earnings so far and 81% of them have topped expectations.

Last Week

While inflation data was clearly a negative for both stocks and bonds last week, other economic data provided a mixed bag. Weekly jobless claims were 267,000, lower than expected and a drop of 4,000 from the previous week, creating a new pandemic era low. The University of Michigan consumer sentiment index in November fell to 67, representing the lowest level in 10 years as inflation rose to the highest level in more than 30 years. Rising prices for homes, vehicles and durables were cited by consumers as having the greatest impact. The low consumer confidence level also comes at a time when President Joe Biden’s approval rating has plunged below 40%.

For the week, the Dow Jones Industrial Average fell 0.6% to close at 36,100 while the S&P 500 Index dropped 0.3% to close at 4,682. The Nasdaq Composite Index declined 0.7% to close at 15,860.

This Week

Retail sales in October are expected to increase moderately and exceed gains reported in September while October housing starts are also expected to be higher than in the previous month. Leading economic indicators in October are forecast to be much stronger than in September and the Conference Board is predicting GDP growth of 5.7% for the entire year.

Retailers will be in the earnings spotlight this week as Home Depot, Lowe’s, Walmart, Target, Kohl’s, Macy’s, TJX Companies, Williams Sonoma and Foot Locker are scheduled to report. Other notable companies on the agenda include Cisco Systems, Nvidia, Applied Materials, Palo Alto Networks, Tyson Foods and Advance Auto Parts.

Portfolio Strategy

The focus this week will be squarely on the consumer as October retail sales data will be released and most of the prominent third quarter earnings reports will be from the big retailers. While these earnings reports and retail sales data are backward-looking, they come on the heels of the University of Michigan consumer sentiment index that dropped to a 10-year low as consumers are becoming increasingly concerned over the sharp rise in inflation. Many of these companies have had to deal with labor shortages and supply chain disruptions that have affected their inventory and forced them to raise prices to offset rising costs. With the holiday shopping season just around the corner, this is a critical time for retailers as these sales make up a significant portion of their annual revenue. Fortunately for retailers, many consumers have been vaccinated and are less fearful about shopping in public. Consumers also have extra money from government stimulus payments and even more wealth created by huge gains in the stock market. While the pandemic greatly reduced mall traffic and hurt the performance of physical stores, it forced retailers to reevaluate their business model by closing poorly performing stores and improving their e-commerce operations. As consumers return to the mall to shop in person, retail sales this holiday season are expected to jump nearly 10% over last year. This week’s retail earnings reports, particularly from the big box retailers like Walmart, Target and Home Depot, will enable investors to see the effect that rising costs are having on their profit margins. Since consumer spending accounts for roughly two-thirds of all economic activity, this week will provide important clues as to the health of consumers as we head into the holiday shopping season.