Markets enjoyed an energetic bounce on Friday following weaker than anticipated economic news. Wage growth was slower than expected, and the PMI report was surprisingly soft. This data increased the chances of a 0.25% hike rather than a 0.5% increase at the next Fed meeting at the end of the month.
Market participants are still very focused on inflation as the primary economic issue. That means that bad economic news is greeted as a positive as it indicates that inflationary pressures are slowing. CPI appears to have peaked and is starting to trend down, but the Fed remains very worried about employment-related inflation. The news on Friday seemed to indicate some relief in job-related pressures.
The Fed has made it very clear that it still has a long way to go in the battle against inflation. Strategists expect at least three more 0.25% hikes this year and no rate cuts.
However, while Fed policy appears to be working as far as inflation, the question that will become the main focus very fast is how much economic slowing is taking place. Strategists at Moran Stanley, Goldman Sachs, and other major firms are convinced that earnings estimates are still too high.
Ironically slowing inflation is a factor that will hurt earnings. Corporations will not be able to raise prices as inflation cools, and margins will likely be squeezed.
Some strategists believe that the market has already discounted weaker earnings to a great extent, but Mike Wilson of Morgan Stanley, who was ranked the top strategist last year by Institutional Investor, is concerned that the earnings shortfall could be much greater than expected and drive the S&P 500 as low as 3000.
Earnings season will start in about two weeks, and we will quickly see the developing themes. In the meanwhile, we have a CPI report on Thursday, and there will be a parade of Fed speakers that are intent on keeping expectations low.
Market players felt some relief on Friday, but generating a sustained uptrend will be extremely difficult as the market struggles with economic issues and the potential for weak earnings.
