Jumping January: PPI Adds to Hot Inflation Picture as Investors Retreat

(Thursday market open) Investors awoke Thursday to a red-hot January Producer Price Index (PPI) gain of 0.7%, showing lack of progress in the inflation fight. Stock index futures extended early losses after the data.

Investors also grappled with weekly initial jobless claims and Philadelphia Fed data while they digested a solid earnings report from Cisco (CSCO) released late Wednesday. The S&P 500® index (SPX) finished a few ticks below 4,150 yesterday, and that remains a tough resistance point that’s held up very well. Technical support could be near 4,100.

While “buy the dip” characterized the market earlier this week on pullbacks, it could be harder to find enthusiasm today after PPI.

Just in

Consensus ahead of the PPI data had been for a 0.4% rise in headline PPI and a 0.3% rise in core PPI, according to Briefing.com. Investors got 0.7% and 0.5%, respectively.

Today’s report shows that input costs for businesses remain elevated, and if companies choose not to pass them along to customers, they’ll see their profit margins get hurt. This isn’t a good report for equities, offering evidence that investors had grown a little too optimistic about the trajectory for inflation. There’d been hopes that with inflation moderating, the Federal Reserve could pause rate hikes later this year, but a report like this suggests the market had grown too optimistic.

Weekly Initial Jobless Claims of 194,000 came in below expectations, another sign of the hot economy not cooling down. At the same time, February’s Philadelphia Fed Index reading of -24.3 was well below Wall Street’s consensus. This is the kind of data the market doesn’t want to see: rising inflation accompanied by a sign of economic weakness in the Philly Fed reading.

Looking for any positives? Nearly 1.6 billion passenger trips were made in China during the Spring Festival travel rush that ended Wednesday, according to the country’s Xinhua news agency. That’s up more than 50% from a year ago, suggesting that the reopening is picking up steam. Asian stocks finished mostly higher Thursday.

Morning rush

The 10-year Treasury note yield (TNX) jumped to 3.83% after the PPI data.
The U.S. Dollar Index ($DXY) jumped above 104.
Cboe Volatility Index® (VIX) futures were solidly up at 19.52.
WTI Crude Oil (/CL) was steady at $78.81 per barrel.

Stocks in spotlight

Cisco (CSCO) shares leaped 6% in premarket trading after the networking equipment provider’s earnings report and positive forecast beat Wall Street’s estimates.

Growth in CSCO’s core networking business that connects devices, users, and applications could signal an improving business economy because most companies rely heavily on these products but pull back if they anticipate tough times. That’s why CSCO’s results are often seen as a proxy for general corporate health.

CSCO’s strong quarter also contrasts with some other tech companies that reported slower growth and cut jobs recently. Could CSCO’s impressive showing be a harbinger of better things ahead of the industry, or is it the exception? Investors might have to go one earnings report at a time, though CSCO’s solid quarter raises hopes for the entire info tech sector. Nvidia NVDA, the next big tech company on the calendar, is expected to report earnings next week.

Mega-cap tech stocks: As major indexes remain near recent peaks, companies like Tesla TSLA, Alphabet GOOGL and Microsoft MSFT have helped keep them there.

This has some analysts worried about a top-heavy market. The S&P 500 index (SPX), heavily weighted toward mega-caps, looks strong on the surface but could hide weakness within. A “breadthless rally” like the one in 2018 isn’t usually one that lasts. If you’re bullish about the market, it’s far better to see a rally that lifts all boats.

What to watch

Applied Materials AMAT is expected to report after the close, providing more insight into the semiconductor sector. AMAT makes chip manufacturing equipment, which offers a bird’s eye view of industry demand. Some analysts are a bit gloomy about the company’s 2023 prospects, but AMAT did beat analyst estimates on revenue and earnings per share (EPS) last time it reported, though its press release then cited “geopolitical and macroeconomic challenges.”

Leading indicators: Tomorrow, January’s Leading Economic Index report from the Conference Board will wrap up a wild trading week ahead of the long Presidents Day weekend. This particular metric has been down 10 straight months, reinforcing ideas that the United States could face a recession, according to Charles Schwab’s Chief Investment Strategist Liz Ann Sonders.

Consensus on Wall Street is for a 0.3% drop in January Leading Indicators that would extend the streak, according to Briefing.com.

Deere DE is expected to report Friday morning before the open. As a large multinational agricultural equipment maker, DE is particularly exposed to moves in the dollar. It could be interesting to see if the dollar’s decline from last year’s 20-year highs might’ve provided a bit of a tailwind for DE in the quarter that just ended.

DE shares jumped when it reported last November, lifted by its stronger-than-expected 2023 revenue guidance based on “positive farm fundamentals” and greater investment in farm infrastructure. As for how those fundamentals have held up, look to crop prices, notably corn and soybeans. Both are near historically high levels but below their 2022 peaks. Still, both crops remain at profitable levels as the Northern Hemisphere’s planting season nears, and a healthy farm economy often means a healthy DE.

Market Minutes

Here’s how the major indexes performed Wednesday:

The Dow Jones Industrial Average® ($DJI) climbed 38 points, or 0.11%, to 34,128.
The Nasdaq Composite® ($COMP) rose 0.92% to 12,070.
The Russell 2000® (RUT) rose 1.09% to 1,961.
The SPX climbed 11 points, or 0.28%, to 4,147.

After a sluggish start Wednesday due to a hot read on January Retail Sales, the major indexes took off at midday and kept humming along to finish at or near daily highs.

This rally came despite selling in Treasuries that took the 10-year Treasury note yield above 3.8%, its highest since the end of 2022. The 10-year yield is up nearly 14% from its February 2 low—a very steep gain in so short a time. That high-powered move helped arrest the stock market’s January rally but didn’t dash it against the rocks. The SPX is down less than 1% from February 2. That’s pretty resilient considering how stocks usually react to rapidly climbing rates.

It’s also interesting to see growth stocks—the very companies you’d normally worry about when rates rise—lead the charge so far in February. We talked about info tech above, but consumer discretionary has also joined in. Small caps, which are also yield-sensitive, had been lagging large caps recently but outpaced them Wednesday. It’ll be interesting to see today if this is perhaps the start of a new trend.

Defensive sectors like staples and utilities lagged yesterday, as they have over the last month, though utilities are particularly vulnerable to rising yields.

Talking technicals: Wednesday marked the second day in a row of late-session gains for the major indexes coming off losses earlier on. While there’s no firm and fast rule, late-session recoveries often signal healthy buying interest on any dips and can sometimes spill over into the following session. That said, the SPX, $COMP, and $DJI are all near recent peaks, and no buyers seem eager to carry them over the previous highs. So that suggests a rangebound, choppy trade could persist until some new major catalyst comes along.

CHART OF THE DAY: Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Thinking Cap

VIX alarm: We often tell traders to watch the Cboe Volatility Index (VIX) futures for a sense of what type of markets might be up ahead. So far this month, the VIX has been pretty tame despite a sharp climb in Treasury yields that could signal fears of future Fed rate hikes. In fact, the VIX fell below 19 early Wednesday despite this week’s one-two punch of bullish January Retail Sales and January Consumer Price Index (CPI) data. Both pointed to potential higher rates and possible challenges for stocks, which would normally send the VIX higher. Looking ahead, however, the VIX futures complex doesn’t show anything too alarming, just a slight tilt higher toward 20 by mid-March and 21 by mid-April. September VIX futures trade at 23. The values from March through September are below where they were just a few days ago. The VIX doesn’t show signs of testing the key 25 level anytime soon. The VIX move above 25 last fall coincided with an SPX well below 4,000.

Career week at the Fed: Reports circulated Wednesday that new Federal Reserve Bank of Chicago President Austan Goolsbee could get the White House nod to take Lael Brainard’s place as vice chairman of the Federal Reserve. Brainard, known as a policy dove, was named earlier this week as President Biden’s top economic advisor. Goolsbee, a former economic advisor to President Obama, took the Chicago Fed post in December and is a voting member of the Federal Open Market Committee (FOMC). Could a Goolsbee appointment quiet the nerves of those worried about a less-dovish voice at the Fed? According to The Wall Street Journal, if Goolsbee is named vice chair, the Cleveland Fed’s Loretta Mester would take his place as a voting member of the FOMC until a new Chicago Fed president is named. However this game of musical chairs plays out, it seems unlikely to affect policy. Back in December when the FOMC last delivered rate projections, its “dot-plot” featured only two dissenters who thought rates shouldn’t climb above 5% in 2023. Was Brainard one of them? We’ll never know because the Fed doesn’t break out projections by name.

Dot-plot dreaming: A new dot-plot’s due at the next Fed meeting scheduled for March 21 – 22. Expectations have already grown for the Fed to raise its terminal, or peak rate, to above the current 5% to 5.25% range that it unveiled in December. One former Fed official told CNBC Wednesday he could see the terminal rising to 5.5% or above. But what happens in 2024? The FOMC’s rate projections for next year were all over the place on the December dot-plot, from a low range of between 3% and 3.25% to a high range of 5.5% to 5.75. On average, however, the FOMC felt that rates could come down to around 4% in 2024. Will that remain the case when the March dot-plot debuts? In December, there were inklings that the Fed’s fight to slow the economy and ease inflation might be working. But following the January Retail Sales, Nonfarm Payrolls, and CPI data, that seems less clear. There’s more data before the March meeting; however, continued economic momentum may force the Fed’s hand when it comes to imagining any sort of rate decline in 2024.