Next Week’s Inflation Report: A Potential Market Shake-Up?

The financial markets are currently experiencing a period of heightened optimism, with stock prices reaching lofty valuations. However, this seemingly idyllic scenario faces a potential disruption: the release of next week’s inflation data. The upcoming November Consumer Price Index (CPI) report, scheduled for Wednesday, December 11th, is anticipated to reveal a slight increase in inflation. While a modest rise might be absorbed, a surprisingly strong report could derail the ongoing rally and trigger significant market corrections, potentially impacting the Federal Reserve’s upcoming interest rate decision later this month. This precarious balance of optimism and potential volatility highlights the crucial role of inflation data in shaping current market sentiment and its direction.

Key Takeaways: Inflation, Interest Rates, and Market Volatility

• Next week’s CPI data could significantly impact market performance, potentially derailing current bullish sentiment.
• A higher-than-expected inflation reading might hinder the anticipated December rate cut by the Federal Reserve.
• Currently elevated stock valuations (exemplified by the high P/E ratio of the S&P 500) leave the market vulnerable to a correction.
• Despite potential short-term volatility, many analysts remain bullish on the long-term outlook for stocks, predicting renewed gains after the current data-driven uncertainty passes.
• Strong earnings reports from tech companies, coupled with sector rotation, have contributed to a recent market rally, but this enthusiasm could be tempered by upcoming inflation figures.

Inflation’s Potential to Disrupt the Market’s “Perfection”

The markets appear to be operating under the assumption of a “perfect” scenario: continued economic growth, tempered inflation, and supportive monetary policy from the Federal Reserve. However, the upcoming CPI report poses a potential challenge to this assumption. FactSet predicts a 0.2% month-on-month and 2.6% year-on-year increase in November’s CPI. While this represents no change from the previous month, continued inflation stubbornly above the Federal Reserve’s 2% target rate could be enough to alter expectations.

Jay Woods, chief global strategist at Freedom Capital Markets, notes that, “For all of 2023, and the first half of 2024, the CPI moved markets, and it has the potential to do that again.” He predicts that while a surprisingly high CPI report might not completely halt the current rally, it could trigger a 2-3% retracement. This underscores the sensitivity of the market to inflation data, particularly given the currently elevated valuations.

Elevated P/E Ratios and Market Vulnerability

Oppenheimer’s analysis reveals that the S&P 500’s P/E ratio has reached 26, a level 32% higher than the average since 1989. This high valuation leaves the market susceptible to correction, as investors might reassess their expectations in the face of unexpectedly high inflation.

The Bullish Outlook: Santa Claus Rally and Growth Expectations

Despite the looming threat of a potential market correction, many analysts remain optimistic about the market’s long-term prospects. Tom Lee, head of research at Fundstrat Global Advisors, expects the S&P 500 to reach 6,300 by the end of the year, suggesting the market might quickly recover from any dip. He encourages investors to “Buy the dips“. Similarly, Woods anticipates the S&P 500 ending the year around 6,220, even accounting for potential setbacks.

This bullish sentiment stems from a combination of factors: strong fundamental setups, buoyant investor optimism, and expectations for a “Santa Claus rally” in the period between now and the new year. The belief is that once the current uncertainty surrounding the FOMC meeting and inflation data subsides, investor confidence will increase, spurring additional market gains. This illustrates the interplay between short-term risk and long-term prospects that investors are currently grappling with.

Recent Market Performance and Sector Rotation

The recent market performance has been characterized by both overall gains and a degree of sector rotation. A significant tech-led advance saw the S&P 500 rise 0.8% and the Nasdaq Composite surge 3.2% this week. This rally was fueled, in part, by positive earnings reports from mega-cap tech companies and renewed confidence in the sector’s artificial intelligence capabilities. The success of Salesforce, exceeding investor expectations, played a pivotal role in this resurgence.

The Technology Select Sector SPDR Fund (XLK) reached a new high since July, rising around 3%, indicating the extent of tech’s influence on the current market climate. Woods points out that, “We’re seeing rotation from sector to sector, and now we’re seeing rotation within the sectors… And to me, this is very fascinating, because money is not leaving the market. Money is staying in the market.“

Growing Concerns and Contrarian Views

Despite the optimism, the recent market surge has raised concerns that the market might be becoming overheated. The recent rise in Bitcoin’s value (topping $100,000) and the robust performance of Cathie Wood’s Ark Innovation ETF (ARKK, up 7.8% this week) signal a growing level of risk appetite. Such indicators could point towards a possible market exuberance.

This increased bullish sentiment has prompted contrarian investors to anticipate a potential market crash. The American Association of Individual Investors (AAII) report shows a sharp rise in bullish sentiment for the next six months from the previous week – **48.3% up from 37.1%**, which is above the **historical average of 37.5%**. This suggests a potential divergence between market behavior and underlying economic fundamentals, triggering concerns about an imminent market correction. The question lies in whether this enthusiasm is sustainable in the coming months.

Upcoming Economic Releases and Earnings Reports

The week ahead is packed with important economic indicators and earnings reports that could further influence market sentiment. The calendar includes:

• Monday, December 9th: Wholesale Inventories (October), Oracle earnings.
• Tuesday, December 10th: Unit Labor Costs (Q3), Productivity (Q3), AutoZone earnings.
• Wednesday, December 11th: CPI (November), Hourly Earnings (November), Average Workweek (November), Adobe earnings.
• Thursday, December 12th: Continuing Jobless Claims, Initial Claims, Producer Price Index (November), Broadcom and Costco earnings.
• Friday, December 13th: Export Price Index (November), Import Price Index (November).

The release of these figures will provide further data points for assessing the state of the economy and its potential impacts on the financial markets. Investors are keenly awaiting this further information to refine their assessments.

In conclusion, the current market environment presents a delicate balance between optimism and uncertainty. While strong earnings and investor confidence have fueled a recent rally, the potential for a market correction due to upcoming economic data and high valuation remains a significant factor. Analysts hold differing opinions on the short-term outlook and the impacts of the potentially volatile CPI report. The coming days will be imperative in seeing how the market handles the upcoming challenges.