Weekly market wrap

A View from the Peak

Key points:

• The April U.S. consumer price index (CPI) report released last week soothed fears that a new wave of inflation pressures was emerging. While inflation is still too high for comfort, the latest data signaled that consumer price pressures are gradually moderating in the U.S., a trend that has been more favourable in Canada so far this year. 
• Stocks rallied and interest rates pulled back on the combination of better-than-expected inflation (supporting a case for U.S. Fed rate cuts at some point this year) and strong corporate earnings announcements. 
• Stocks reached new all-time highs last week. While we anticipate more bumps along the way as we advance, we don't think this represents the ultimate peak for equities, with the combination of ongoing economic growth, rising profits, and less-restrictive central banks offering a positive backdrop for the bull market to continue.

Not only do peaks have two sides, the ascent and descent, they can also represent opposing conditions. A player for your favorite team peaking during the playoffs – good. Your blood pressure peaking as your team misses the playoffs – not so good. The relationship between inflation and the stock market has been particularly acute for some time now, with the peak in the former playing a key role in that of the latter. It matters which side of the peak you're on.

We'd assert that, currently, we're on the favourable side of each. Inflation is descending and equities are on the ascent. Now the question is: "Can both continue?" Domestic stocks have hit new highs and the Dow reached a new summit last week, briefly touching 40,000, thanks to a better-than-expected U.S. inflation report¹. Here are a few perspectives on why we think inflation's peak will remain in the rearview mirror and the peak in equities is still further down the road:

The U.S. inflation report the market needed. 

• The peak:
  • Overall inflation peaked in 2022, with headline CPI topping out in the summer amid surging food and energy prices. Core CPI peaked in September, as supply chains began to heal, input prices started moderating, and restrictive Fed policy started to bite. While consumer prices across the board were reaching 40-year highs due to pandemic impacts, notable drivers of surging core inflation were increases in the prices of used cars, leisure and hospitality services, and shelter (home prices and rents)¹.

Inflation is well off the peak, but it is still too high.

• The descent:
  • Last week brought the release of the much-anticipated April U.S. CPI (consumer price index) report. The outcome was just what the market was hoping for, with inflation appearing to resume its trend of moderation after a string of hotter-than-expected reports in the last few months sparked a bout of market anxiety, as investors fretted the likelihood that the Fed would need to wait longer before cutting rates. 
  • The underlying trends in the CPI release were encouraging.  Overall U.S. core CPI fell to 3.6% on a year-over-year basis, the lowest reading in three years¹. The recent source of upward pressure has been insurance premiums, which showed some early signs of abating last month. Similarly, prices for services, which have remained stubbornly high of late, eased in April, while goods prices continued to decline outright, helped by falling auto and home-furnishing costs. Shelter remains the fly in the ointment, with prices moderating, but only gradually.

Core inflation cooled in April, thanks to relief in services prices.

• The path ahead:
  • The good news is that inflation looks to us like it will remain on its broader path of moderation. April's U.S. CPI report went a long way to soothing fears that inflation pressures were reigniting, which we think keeps the prospects of a rate cut from the Fed on the table, though likely not until much later in the year.  By comparison, inflation pressures have been more muted recently in Canada, a trend we ascribe partly to weaker economic activity in Canada compared to the U.S. Nevertheless, we think inflation conditions in Canada create a credible case for the Bank of Canada to pursue a rate cut slightly sooner that the Fed. 
  • We're watching a few key trends: 1) we're going to need to see more help from shelter prices. Timely data on rents suggests to us that we'll get that help in the months ahead, but this is likely to be slower than anyone would like. Also, we think the low-hanging fruit of disinflation that has come from improving supply chains has largely been realized.  Persistent consumer price measures have leveled out, and goods prices, while still in decline, are likely to provide less help ahead. This is where some softening in the overall pace of economic growth and consumer demand can have a silver lining, as it should allow consumer prices, particularly in the more enduring services segments, to moderate further.

The next leg lower for inflation will require more help from shelter prices. 

The elevation the market deserves.

• The peak:
  • The stock market's post-pandemic peak came just a few days into 2022 following a stimulus- and economic-reopening-driven surge in stock prices through 2021. That party came to an end in 2022 at the hands of central bank rate hikes aimed at snuffing out the inflation fire mentioned above¹. 
  • Stocks fell into a bear market in 2022, bottoming in October, as markets found footing from the peak in inflation and a growing view that the eventual end of rate hikes was within sight¹.

Stocks hit a new high last week.

• The climb:
  • The new bull market that began in October 2022 has not been without its setbacks, which have largely come from episodes of indigestion around the Fed keeping rates high for longer. Nevertheless, the S&P 500 has had a return of nearly 52% since then, including rising more than 10% so far in 2024, which was aided by a better-than-1% gain last week, the fourth consecutive weekly gain for the index¹. 
  • While a good portion of the market's ascent since 2022 has been powered by the prolific gains in the technology sector (and the so-called "Magnificent 7" and enthusiasm around AI in particular), we'd point out that leadership has begun to broaden more recently, which we view as a positive sign for the longevity of this bull market. We've seen leadership in recent weeks come from cyclical areas, like industrials and financials, as well as more defensive and rate-sensitive areas, like utilities.

The rally to new highs has been driven by more balanced leadership.

• The path ahead:
  • There is little doubt in our mind that both the stock and bond markets will continue to take their performance cues from the expectations for upcoming Fed and Bank of Canada policy moves. That should be a pillar of broader support, given our expectation that the next move from each will be a cut. In that regard, the April U.S. CPI report was key in preserving hope that the Fed could act at some point this year. However, we doubt upcoming inflation readings will be consistently better than expected, which likely introduces some bouts of volatility, as the market wrings its hands over the exact timing of a potential cut¹. 
  • Lost in this peak obsession over the Fed, however, is another peak that we think will provide the horsepower for this bull market to continue: corporate earnings growth. Corporate profits, should, in our view, reach a new high this year. Helped by ongoing economic growth and less punitive interest rates, we think the growth in earnings – currently expected to rise by double-digits in 2024 – will set the pace for equity-market gains ahead.
  • Stocks hit a record high again last week, with the S&P 500 having now gained 10% since reaching a new high-water mark at the beginning of this year. The upshot: history shows that after surpassing previous peaks, stocks have, in most cases, gone on to log strong gains¹.

Stocks have typically extended gains after surpassing prior peaks.

We think rising earnings will support further market gains over time. 

Other peak perspectives.

• Dow 40k:
  • The Dow briefly eclipsed the 40,000 mark for the first time ever on Thursday of last week. Is this significant? Well, no more so than Dow 39,927¹. It's human nature to focus on round numbers or milestones like this, but the figure itself is not particularly significant. Instead, what is significant is what that represents, as it reflects a sizable rally in stock prices over the last few months, as well as over the last few years. During that stretch, there were growing choruses citing economic and Fed policy risks, along with the allure of elevated money-market and GIC yields. Yet, the strong gains in equities are another reminder of the power of a longer-term perspective and an opportunistic investment approach.

The Dow since 1980.

How has the Dow fared after hitting round-number milestones?

• Interest rates:
  • We think the mark that 10-year yields touched last October will prove to be the peak within this monetary policy-tightening cycle. After a run higher to start 2024, we've seen yields move lower in recent days, as the latest inflation data and commentary from the Fed have eased concerns of more restrictive policy moves ahead. Domestic yields have trended below those in the U.S. more recently, reflecting more modest growth and inflation trends as well as expectations for rate cuts from the Bank of Canada to come sooner than the Fed¹.

We think longer-term interest rates have peaked for this cycle.

• Oil and Gold: 
  • Oil's recent peak above $120 per barrel came amid the reaction to both the reopening of the global economy as well as the war between Ukraine and Russia¹. While recent tensions in the Middle East and Iranian involvement pose uncertainties to global oil production, oil prices have failed to respond with a dramatic move higher, now sitting more than 35% below that 2022 peak. Meanwhile, gold prices have moved notably higher of late, reaching a new peak above $2,400. While some of this run earlier this year was likely a response to hotter inflation readings, we suspect there may also be some growing demand for gold coming from global central banks, as well as some defensive posturing within the markets even as equities have rallied to new highs¹.

Gold and oil performance has diverged recently.

• The return of meme mania:
  • Last week brought shades of 2021 and a reminder of another peak – the peak in the speculative-asset mania during that time that saw the rise of the so-called "meme stocks." Last week, shares of GameStop and AMC found their way back in the headlines after shares spiked dramatically.  The chart below shows how this compares with the mania peaks in 2021. We'd also point out that despite AMC shares rising more than 100% in a matter of days last week, this gain barely shows up on the chart, a sign of just how far these share prices have fallen from their highs during that 2021 speculative bubble. We don't view this as a sign that we're returning to the level of speculation or investor sentiment that we saw during that period, but we do think this is somewhat indicative of the risk-taking that tends to emerge during strong market runs¹.

Meme stocks that peaked in 2021 were back in the headlines last week.

Craig Fehr, CFA
Investment Strategy

^{Source: 1. Bloomberg}

Weekly market stats

^{Source: FactSet, 5/17/2024. Bonds represented by the Bloomberg Canada Aggregate Bond Index. Past performance does not guarantee future results. *4-day performance ending on Thursday.}

The Week Ahead

Important economic releases this week include domestic CPI and retail sales data.