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Investors might want to keep their guard up as the stock market continues its rally.
“The market has kind of gone back to sleep” in appearing to think, “all right, mission accomplished, inflation’s in the bag, the Fed can back off,” said Sameer Samana, a senior global market strategist at Wells Fargo Investment Institute, in a phone interview Wednesday. “We think it’s much too premature.”
Samana cautioned that inflation remains elevated even after easing in July. Core inflation, which strips out food and energy, will probably remain “stubbornly” high as areas such as wage growth and shelter costs tend to be stickier, which will probably remain a “problem” for the Federal Reserve, he said.
U.S. stocks rallied Wednesday, with the technology-heavy Nasdaq Composite entering bull market territory, according to Dow Jones Market Data.
Investors should remain defensive, according to Samana, who said that Wells Fargo likes healthcare and is overweight the sector while recently upgrading consumer staples and utilities to neutral. He expects a recession to start in the second half of this year, although “we don’t think equity markets are reflecting that.”
Read: ARK’s Cathie Wood: U.S. already is in a recession, may exit in 2023
Wells Fargo Investment Institute also likes energy and technology, said Samana.
“We like tech because of its focus on the business of the enterprise customer,” as opposed to consumers whose discretionary spending may crimped, he said. Samana said that “companies will probably make it through this next recession in slightly better shape than consumers, which will have a pretty difficult time with higher borrowing costs” and high inflation.
U.S. inflation, as measured by the consumer-price index, was unchanged in July, after jumping 1.3% in June, for an annual rate of 8.5%, the U.S. Bureau of Labor Statistics reported Wednesday. The pace of inflation over the past 12 months has slowed from 9.1% in June.
Read: U.S. consumer price inflation surprises to downside in July
July inflation was lower than expected, said George Catrambone, DWS Group’s head of Americas trading, in a phone interview Wednesday. “The core was better than people had feared.”
Core CPI, which excludes food and energy, rose 0.3% in July, slowing from a 0.7% increase in inflation in June. Economists polled by The Wall Street Journal had forecast that the consumer-price index increased 0.2% in July and that core inflation rose 0.5%.
“There’s some optimism to be had based on some of the data that we’ve seen,” Catrambone. “But if the market continues to rise, you will see valuations start to become stretched again.”
In his view, “the market is getting ahead of itself,” with the S&P 500 now trading at a forward price-to-earnings ratio of around 17.5 even as the Fed remains committed to a 2% inflation target. Plus, “global headwinds” remain, he said, pointing to concerns over the Russia-Ukraine war and geopolitical tensions between the U.S. and China with respect to Taiwan.
Catrambone said he worries that “the market is ignoring” how much work the Fed says it has yet to do in bringing down inflation by raising its benchmark interest rate.
U.S. stocks closed sharply higher Wednesday, with the Nasdaq Composite leading the way up. The S&P 500
SPX,
rose 2.1% to finish at 4,210.24, while the Dow Jones Industrial Average
DJIA,
rose 1.6% and the tech-laden Nasdaq
COMP,
surged 2.9%, according to FactSet data.
Investors “should be focusing on profitable tech, quality within the tech sector,” suggested Catrambone.
Steve Chiavarone, head of multiasset solutions at Federated Hermes, said he’s been underweight tech “for the better part of the year” and is “neutral” when it comes to stocks versus bonds.
“Tech has been trading on interest rate expectations,” Chiavarone said by phone Wednesday, with growth stocks such as tech being hurt earlier this year in anticipation of the Fed hiking rates to combat soaring inflation. Now the market seems to be looking ahead to a potential Fed pivot, where the central bank would pause hiking as peak inflation eases in a potential recession and then cuts rates.
“I think that’s too cute by half,” Chiavarone said. “I think all of this is going to take longer” to play out.
While Wednesday’s stock market rally reflects some “relief” after the inflation reading for July was better than expected, “I don’t think it’s a game changer,” he said. “Energy prices came down, which is good,” he said, but core inflation over the past 12 months remained steady at 5.9%.
“Financial conditions are looser now” than before the Fed hiked in July, although the Fed is aiming to tighten its monetary policy to lower inflation, said Chiavarone.
