Get out of your Wednesday plans.
On June 12, the May consumer-price index will be released at 8:30 a.m. Eastern, and then the Federal Reserve’s two-day policy meeting will end at 2 p.m. This is a double whammy for stock market investors.
Each CPI day and Fed day has its own reputation for market volatility. Maybe good news for investors is that they won’t have to wait long for Fed Chair Jerome Powell to say what the central bankers think of the May inflation data.
People think that policymakers will probably not change interest rates when the two-day meeting is over. However, when they think they will be able to make rate cuts, which have been hard to predict, will be the main topic of discussion.
Investors thought that rates would drop by six or even seven quarter percentage points starting in March 2024. A number of higher-than-expected inflation and job reports, including the May employment report released on Friday, have caused fed-funds futures traders to price in two rate hikes at most, possibly starting in September.
But stocks have gone up even though expectations of a rate cut have dropped. Strong economic data has given people hope for strong earnings growth this year and next.
That’s what worries some investors, who say that the rally has made prices too high for stocks, leaving them open to disappointment.
Statista says that the S&P 500’s forward 12-month price-to-earnings ratio is 20.7. This is higher than the average of 19.2 over the last five years and 17.8 over the last ten years.
Josh Emanuel, chief investment officer at Wilshire, said over the phone, “Equity valuations are high right now, and this really needs to be an earnings growth story going forward.”
Analysts on Wall Street expect the S&P 500 to earn about 25% more in 2024 and 2025, so there isn’t much room for error, he said.
Treasury yields went up after the May jobs report, but stocks held their own for most of Friday. The S&P 500 SPX and Nasdaq Composite COMP were close to ending the day at all-time highs before a late-day pullback left them with small losses.
The U.S. added 272,000 more jobs than expected in May, according to data released on Friday. This suggests that the economy is still pretty strong and makes it less likely that the Federal Reserve will cut interest rates soon. But the unemployment rate went up from 3.9% to 4%. This is the first time since January 2022 that it has been that high.
Average hourly wages rose at a rate of 4.1% year-over-year, up from 4% in April. This may be the most troubling thing for Fed policymakers. It is important for the Fed to see growth close to 3% so that inflation stays low.
It was still a good week for stocks: the Dow Jones Industrial Average (DJIA) went up 0.3%, the S&P 500 went up 1.3%, and the Nasdaq went up 2.4%. The tech-heavy Nasdaq has gone up over 14%, while the S&P 500 has gone up more than 12%. The more volatile Dow is only up 2.9% so far this year.
Of course, technology stocks have been the big story of 2024. Last week, Nvidia Corp. NVDA, 1.16% became the first company in the world to have a market capitalization of $3 trillion. As the name suggests, the S&P 500 equal weight index doesn’t weight its components by size, but rather treats them all equally. It is only up 4.3% so far this year, which shows how much megacap tech giants have affected the index.
After the jobs report, the Treasury market adjusted, which drove up yields. Emanuel said that stocks should do the same.
When Treasury yields go up quickly, it can make stocks less stable. While higher yields mean higher interest rates on loans, they can also make stocks less appealing compared to bonds because bonds pay higher yields than stocks did before.
Rate markets have been more sensible in response to economic data and fewer chances of rate cuts, Emanuel said. But “equity markets and risk assets have shrugged this off based on the idea that equities will outgrow that valuation headwind coming from higher interest rates.”
“That will be hard to do when earnings growth is already very high, investor sentiment is high, the economy isn’t priced for a recession, and investors are putting more and more of their money into stocks,” he said. “The current situation makes it very hard for stocks to do better than expected.”
In comparison to what people expect, Powell might sound pessimistic. However, the real test will come during the next earnings season, when results will have to live up to higher hopes, Powell said. At the same time, markets may become more unstable.
Wednesday will be a big day for the central bank. Powell will speak, and the central bank will update its Summary of Economic Projections, also known as the “dot plot.”
The dot plot shows how different Fed officials feel about different policy options. Rate cuts will be something investors want to see how many of them are priced in. When the last dot plot came out in March, it showed that policymakers wanted to cut rates by three quarters of a point in 2024.
“We think Powell is likely to keep playing down any talk of more rate hikes, since we don’t see any signs of the economy getting too hot,” said Antti Ilvonen, senior analyst for U.S. macro at Danske Bank in Copenhagen.
Sticky inflation could keep putting off cuts for longer, but he said that the current level of interest rates is probably still seen as tight enough. “This could be another sign that the Fed is easing up on rates.”
