Inflation, Earnings Season, and More

Jerome Powell appeared for his confirmation hearing with the Senate Banking Committee on Tuesday as chairman of the Federal Reserve. Although Powell enjoys broad support from the right and left, both sides are increasingly concerned about inflation.

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Testimony about inflation in front of Congress was a potential minefield for the chairman, but he threaded the needle again, and stock prices popped up. We were encouraged that tech stocks rallied in particular, which bodes well for a bullish trend during earnings season.

A surface-level reading of recent headlines might imply that inflation has been skyrocketing, making the rally off the S&P 500‘s lows a little hard to explain. However, the facts are not as bad as many investors assume.

The Fed prefers to use the Personal Consumption Expenditures (PCE) measure of inflation, which is similar to the Consumer Price Inflation (CPI) in most ways. The PCE gathers its data from businesses rather than consumers (which helps reduce some bias), and it accounts for substitution.

The PCE indicates that inflation has been up 5.7% over the last 12 months, which is high, but it isn’t like revisiting the Weimar Republic or 2007-2009 Zimbabwe (both economies experienced hyperinflation that destroyed their currencies). Our point is to emphasize that the Fed won’t have to use extraordinary measures to curb inflation from where it is.

Investors really wanted to hear that the Fed is going to do what it takes to reduce inflation — or at least fight it from increasing further. The Fed chairman accomplished the objective and soothed the market in that respect. How long that lasts is uncertain, but because market fundamentals are otherwise positive, we think buying off the lows makes sense.

Further, Wednesday’s CPI report for December was a relief as well. The month-over-month CPI numbers have hit 10% in May, July, November, and December. However, the new reading shows that prices “only” rose .5% this month (or 6.2% annually), which is a great sign that the Fed’s threat to raise rates is having its intended effect on the market.

We have tried to make a positive case for setting inflation worries aside for now, but we don’t want to set expectations that short-term volatility is over. Earnings kicked off this week with Citigroup Inc. (NYSE:C), JPMorgan Chase & Co. (NYSE:JPM), and Wells Fargo & Co. (NYSE:WFC) reporting today, which could cause some ripples in the market.

The recent rally in interest rates has driven most bank stock prices back to resistance. The downside to the recent rally is that the banks will have to include a surprisingly positive outlook to avoid profit-takers at these technical levels. Although any corrections will be short-term problems, it means we may see some volatility today and Monday.

Earnings season starts to heat up next week, with 34 S&P 500 components reporting between Jan. 17-21. Most of these will be banks and consumer defensive stocks, but a few interesting tech/retail reports like Netflix (NASDAQ:NFLX) could give us a little more insight into how much sentiment has improved.

According to Zacks Research, the average estimate for earnings growth in the fourth quarter is 19% on a revenue increase of 11.6%. Factset‘s estimates are a little higher but mostly in line with Zacks. Those numbers are good, and we don’t think the market will disappoint.

However, what matters the most this quarter is the outlook for the rest of 2022. The biggest risk to the market is a contraction in earnings growth later this year. Estimates for the first quarter are positive but have fallen over the last month, and if companies report a more negative outlook than expected, we may adjust our view and deploy alternative strategies.

Right now, our expectations for forward guidance and actual earnings growth are both positive, so we don’t think any adjustments to our strategy will be needed. However, it’s good to know that contingency plans can be implemented if required.

The Bottom Line

Earnings season kicks off today, and it will likely lead to some extra volatility. We anticipate that any price declines will be short-term, as long as the underlying fundamentals remain positive. Now that we have new inflation data from the CPI, we are more confident that stock prices can avoid more shocks like we experienced last Wednesday when the Fed minutes were released. 

We’ll be back with you on Monday — have a great weekend.

Sincerely,

John Jagerson & Wade Hansen
Editors, Trading Opportunities


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