Stock market selloff 'likely' if next inflation reading disappoints Fed, strategists warn

Stock market selloff ‘likely’ if next inflation reading disappoints Fed, strategists warn

Investors are paying to protect themselves in case the stock market crashes with a key inflation reading due this week, which should show that prices are not moderating as the Federal Reserve would like.

Tuesday’s consumer price index report is expected to show a deceleration in annual price growth to 6.2% in January. Core CPI, which excludes volatile food and energy components and is considered a better underlying indicator than the headline measure, is expected to rise 0.4% month-on-month and 5.5% compared to the previous year.

But one surprising Rising gasoline and used-car prices last month could interrupt the month-long trend of decelerating inflation that caused the S&P 500 to rebound 14% from its low in october.

“Inflation has most likely peaked and now prices are falling, but that doesn’t mean it’s a linear decline – and that’s okay,” said Nancy Tengler, director investments from Laffer Tengler Investments.

Unsurprisingly, last year’s trading sessions were rocky when CPI data was released, with the S&P 500 dropping seven of the 12 reporting days. Over the past six months, the S&P 500 has seen an average move of about 2.6% in either direction on the day the CPI was released — near the highest since 2009 — according to data compiled by Bloomberg.

Traders still remember the September 13 consumer price report, which sent the S&P 500 down 4.3% for its worst CPI session since March 2020.

“As long as the Fed is in hawkish mode, volatility will stay firm,” said Chris Murphy, co-head of derivatives strategy at Susquehanna International Group. “So if the CPI is higher than expected, the market will likely sell off.”

But the stock market’s relatively subdued reaction to the past two months of better-than-expected CPI prints signals that US stocks may have already priced in slowing inflation, according to Bloomberg Intelligence. As a result, there could be fewer turbulent CPI days overall in 2023 if the data calms down further.

The reality, at least for now, is that investors shouldn’t worry because any price rally should be temporary. The problem is that investors have heard this before. If a strong labor market keeps wage growth high and inflation from falling as quickly as policymakers want, the Fed could raise rates more aggressively — or keep them higher longer — than the markets had not anticipated.

“The market may react negatively to a warmer CPI, but this will provide an opportunity for longer-term investors to buy stocks,” Tengler said, noting that any pullback this quarter is a buying opportunity. She added to exposure to the company’s stocks during the selloffs in the third and fourth quarters of 2022, and favors tech stocks like Apple Inc. over the next three to five years and sticks to cybersecurity and cloud services.

But skepticism remains among a large contingent on Wall Street.

“We’ve certainly seen more noticeable coverage recently among investors,” Murphy said.

Contracts protecting against a 10% drop in the largest exchange-traded fund tracking the S&P 500 over the next 30 days currently cost 1.7 times more than options that profit from a 10% rally, according to compiled data. by Bloomberg. The price relationship, known as the put-to-call bias, is hovering at the highest level since August 2022, when a two-month rally in the 503-member index abruptly reversed.

The tech-heavy Nasdaq The 100 index, which has climbed 12% this year on fears of an overly aggressive Fed, just suffered its first weekly loss of 2023 after a chorus of central bankers warned of more restrictive policy. long last week.

Although the fourth quarter earnings season has been better than expected so far, some fund managers fear the worst is yet to come for corporate earnings as the U.S. economy continues to slow or slide into recession. . That raised concerns about whether valuations for technology and so-called growth stocks are too high after the S&P 500 rebounded from its low.

“We need to see the inflation data improve even more,” said Stephanie Lang, chief investment officer at Homrich Berg, whose firm recommends being positioned defensively in favor of consumer staples and corporations. health care. “It is premature to declare victory in the battle against inflation and that a soft landing or rate cuts are inevitable.”

–With help from Matt Turner

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