Week Ahead: Fundamentals are still key

Global stocks ended the week with a strong rally, the S&P 500 closed up more than 2%, while the Tech heavy Nasdaq Composite index was up nearly 4%. However, this was not enough to reverse the steep sell off from earlier in the week, and the S&P 500 still logged its sixth straight weekly decline, the first time it has done so since 2011. After a few false moves, stocks were finally able to break out of their cycle of declines, possibly on the back of some good news about the potential end to China’s strict Covid lockdowns and general oversold conditions attracting bargain hunters. There are also some early bullish signs that could help markets to recover as we move to the second half of May. Peak inflation hopes along with resilient corporate profit margins and 85% of companies beating their EPS expectations for Q1, expectations of more China policy support and a push back by a number of Fed officials on the prospect of a 75bp rate hike have all helped to lift the market mood. However, there are still risks to be aware of, including stagflation fears, a global shift to more hawkish monetary policy, and forced selling in equity markets on the back of steep declines, could all hinder a potential rally in risky assets this week. 

As mentioned above, there are stumbling blocks to a prolonged recovery in market assets. Thus, whether or not a recovery can be sustained could depend on two key fundamental releases this week. 

1. UK CPI data

April’s UK CPI data is expected to be mega when it is released on Wednesday; analysts are expecting a rise in the monthly headline rate of 2.6%, which would push the annual rate of headline inflation up to 9.1%, a huge jump from the 7% recorded in March. If expectations are correct, this would be the highest annual rate of inflation recorded since the index began in 1989. The reason for this is the 54% rise in the energy price cap, which has sent energy prices soaring. This jump in headline inflation is expected, and the Bank of England now expects prices in the UK to peak above 10% this autumn, when the energy price cap is lifted once again. Thus, a market mechanism that was designed to be consumer friendly, is actually the main reason why UK inflation rates are higher than elsewhere, and why they will take longer to decline. The BOE is right to be worried about growth, as persistently high inflation data is expected to crush growth in the second half of this year. Adding to Andrew Bailey’s list of concerns should be the expected jump in core CPI, which is expected to rise to 6.2% from 5.7% in March. The surprise increase in core CPI in March rocked faith in the pound last month. While a large increase in headline CPI is a given due to the energy price cap, confirmation that core prices are continuing to jump higher could cause further damage to a delicate pound. 

The energy price cap is expected to have caused headline CPI to rise by 1.6%, there will also be significant upward pressure on prices from the increase in VAT on hospitality, higher water bills and a rise in telecoms costs. Higher prices have already dented growth in the service sector, which underperformed in March and weighed on GDP growth. This may just be the beginning for service sector contraction, and once this pillar of the UK economy starts to de-stabilise then it is only a matter of time before growth rates sink. Dodging a recession seems unlikely for the UK with this economic backdrop. 

The FTSE 100 has held up fairly well during the recent bout of market turmoil, however the same can’t be said about the FTSE 250, which is still below the 20,000 mark, although it rose in tandem with blue chip stocks at the end of last week. Since the UK is nowhere near peak inflation, unlike the US, we think that UK asset prices could lag their US peers in the coming months, as the chances are higher that US stocks embark on a recovery sooner than their European peers. Likewise, the pound has also taken the brunt of concerns about the UK’s economic outlook. Wednesday’s data is likely to confirm the threat of stagflation in the UK, thus the pound could come under further selling pressure this week, especially versus the dollar, but also the euro. GBP/USD staged a feeble rally at the end of last week, at the start of trading this week it is lower once more. $1.2250 looks like a key level of resistance, with $1.2160 – the low from last week- acting as support for now. EUR/GBP may have fallen back from the £0.8560 highs at the end of last week, however, we expect this pair to trade sideways until the CPI data from the UK is confirmed. If CPI rates are worse than expected, we expect EUR/GBP to continue to rally. 

2. US retail sales 

One of the reasons why US stocks have sold off rather than capitulated over the last 6 weeks, is that the market feels confident about consumer balance sheets in the US. A red-hot labour market and a build-up of savings rates are helping to protect the US consumer. US retail sales data is due for release on Tuesday of this week and the market expects a 0.7% increase in sales for April. 

The interesting thing about US retail sales data for April, is that sales are expected to expand, although the preliminary reading for the May Michigan Consumer Sentiment Index fell to 59.1, the lowest level since 2011. The index plunged nearly 10% from April, reversing recent signs of stabilisation. Buying conditions for durable goods reached its lowest level since the index came into existence in 1978! Added to this, consumer satisfaction with their own financial conditions is at its lowest level since 2013. The other interesting reading from this survey was that inflation expectations are relatively well anchored, at 3%, within the range seen over the last 10-months. Thus, people are complaining about inflation, they may not be keen to buy big ticket items, but this week’s retail sales data could see US consumers continue to spend on themselves, including on air travel and leisure activities. Since inflation in the US is expected to have peaked, and the Fed is pushing back on the prospect of a 75bp rate hike, we could see retail sales remain steady, regardless of weak consumer sentiment. 

Even so, we will be looking at the minutia of the US retail sales report closely, especially car sales and other big-ticket items, to see if spending could moderate down the line. However, a resilient US consumer could boost market sentiment and lead to a further recovery for risky assets this week.