Ahead of Fed meeting, stocks gain on favorable inflation data

The most common cause of low prices is pessimism – sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It’s optimism that is the enemy of the rational buyer. – Warren Buffett

The stock market picked up this week where it left off on the prior Friday by extending its rally across all the major averages. The Nasdaq Composite Index surged over 4% as investors continued to buy beaten down technology stocks while the S&P 500 rose about 2.5%, the broad-based index’s third gain in the last four weeks. It’s been a strong start to the year as the S&P 500 has now rebounded nearly 14% from its recent low in early October and the Nasdaq has risen 11% in the month of January. It was a busy week for fourth-quarter earnings results as about 40% of the companies in the Dow Jones Industrial Average reported earnings and, for the most part, the numbers were not as bad as feared. Investors chose to look at the mixed results through rose-colored glasses and seemed to give companies the benefit of the doubt. Microsoft reported revenues that were in line with estimates and better-than-expected earnings but issued lackluster guidance. Semiconductor manufacturer Intel badly missed on both the top and bottom lines while Tesla reported weaker than expected results but said demand was strong and was optimistic about the future. Industrial giants 3M and General Electric also posted widely different results with the former reporting lower than expected earnings and issuing disappointing guidance and the latter easily topping revenue and profit expectations. While it’s still early in the earnings reporting season, about 70% of S&P 500 companies have posted better-than-expected results, although the amount of earnings above estimates has been less than the long-term average. Investors were also encouraged last week by some of the economic data, most importantly the core personal consumption expenditures (PCE) index. This is the Federal Reserve’s preferred measure of inflation and it showed that prices excluding food and energy rose 4.4% in December from a year ago, the slowest annual increase since October 2021.

Last Week

Gross domestic product (GDP) in the fourth quarter rose at a 2.9% annual rate, slightly better than expected, but slower than the 3.2% growth in the third quarter. The Leading Economic Index fell a full one percent in December, worse than anticipated and an ominous sign that points to a recession. Durable goods orders, however, were much better than forecast as aircraft orders were strong. Weekly jobless claims fell by 6,000 to 186,000, well below estimates and at the lowest level since April 2022. Even the housing market had some positive data as pending home sales in December grew month-over-month for the first time since May.

For the week, the Dow Jones Industrial Average rose 1.8% to close at 33,978 while the S&P 500 Index jumped 2.5% to close at 4,070. The Nasdaq Composite Index soared 4.3% to close at 11,621.

This Week

The January employment index is expected to show that about 190,000 new jobs were created and that the unemployment index edged higher from 3.5% to 3.6%. Construction spending in December is expected to decline slightly while factory orders are forecast to rebound after dropping in November.

The Federal Open Market Committee (FOMC) meets to review its monetary policy and is widely expected to raise the federal funds rate by 25 basis points (a basis point is one hundredth of one percent) to a range of between 4.5% and 4.75%.

Among the most notable companies scheduled to report quarterly earnings this week are Advanced Micro Devices, Meta Platforms, Qualcomm, Alphabet, Apple, Amazon, Amgen, Pfizer, Bristol Myers Squibb, Eli Lilly, Merck, Caterpillar, Waste Management, Honeywell, General Motors, Ford Motor, Exxon Mobil, Phillips 66, ConocoPhillips, McDonald’s, Sysco, Hershey, Starbucks, United Parcel Service, MetLife and Allstate.

Portfolio Strategy

Although this will be another busy week for fourth-quarter earnings reports, the main event will be the Federal Open Market Committee (FOMC) two-day meeting that ends on Wednesday. Stocks gained again last week as it appears that a soft landing of the economy is still possible after the December core personal consumption expenditure (PCE) index showed that inflation continues to fall. While it’s true that inflation is still running well-above the Federal Reserve’s target of 2%, it has come down substantially from its peak and in recent months has been only slightly above this target. After four 75-basis point hikes last year and another 50-basis point hike in December, the Fed is widely expected to raise the federal funds rate by only 25 basis points this week with two more rate hikes by the same amount at its meeting in March and May. If true, this would bring the peak range for the fed funds rate to between 5% and 5.25%, which coincides with the Fed’s prediction of a 5.1% terminal rate back in December. But the bond market believes that the Fed may stop after a March increase of 25 basis points and maintain the rate at between 4.75% and 5%. If one looks at the Treasury market, there is also disagreement as to where the Fed is headed as the 2-year Treasury yield is 4.2%, slightly below the current range of the fed funds rate. The 10-year Treasury yield has also fallen to about 3.5% as this action reflects a slowing economy with the risk of a recession a definite possibility. Stocks have rallied on the hope that the Federal Reserve and Fed Chairman Jerome Powell will be more dovish in light of the favorable inflation data. What the market doesn’t want to hear is that the Fed plans to remain tighter for longer to achieve its goal of only 2% inflation.