(Bloomberg) — Stocks struggled to gain traction as traders awaited inflation data that will shape the outlook for the Federal Reserve’s next steps.
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Equities edged mildly lower after a rebound from Monday’s market meltdown that rattled trading around the world. While the consumer price index probably picked up modestly in July, the annual metrics should continue to rise at a a slow pace. The recent easing of price pressures has bolstered Fed officials’ confidence that they can start to lower borrowing costs while refocusing their attention on the labor market, which is showing greater signs of slowing.
To Chris Larkin at E*Trade from Morgan Stanley, the inflation data will arrive at a key moment for the stock market, which is coming off its most volatile week of the year. In the span of just a few weeks, the discussion has shifted from whether the economy has slowed enough, to concerns it may be getting stuck in the mud.
“Investors will be looking for the numbers to land in a sweet spot — cool enough that no one will be second-guessing the likelihood of a September rate cut, but warm enough to push aside the recession concerns that have rattled the markets recently,” Larkin said.
The S&P 500 hovered around 5,330. The Cboe Volatility Index — the VIX — was fairly stable around 20. That’s after an unprecedented spike that took the gauge above 65 last Monday. That unusual surge has raised some questions on whether the index was actually “overstating” all that stress in the US stock market.
Treasury 10-year yields advanced two basis points to 3.96%.
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Investors slashed equity allocations at the sharpest pace since the onset of the Covid pandemic during last week’s bout of market volatility, according to data from Deutsche Bank AG.
Aggregate allocation to stocks is now in the 31st percentile and underweight, strategists including Parag Thatte wrote in a note dated Aug. 9. Just three weeks ago, exposure was at the top of the historical range in the 97th percentile.
The reduction implies a slowdown in corporate earnings to the “low single digits” compared with an 11% increase in the second quarter, the strategists said.
At least one indicator suggests that last Monday’s drama looks more like a minor meltdown than a harbinger of worse things to come.
Consider the Cboe Volatility Index and the option-adjusted spread on the Bloomberg US Corporate Bond Index. Based on a long-term relationship between the two, the VIX’s close near 39 a week ago was supposed to correspond to a reading of 3.5% in corporate bond spreads. Yet they ended much lower, near 1.32%.
The mismatch between the two suggests the recent downdraft was technical and not indicative of economic doom, according to Bloomberg Intelligence strategists Christopher Cain and Michael Casper. In fact, such abnormal disconnects in the past have led to above-average returns for stocks over the next three-to-six months.
Reduced equity positioning and a resumption of buybacks after a blackout period present a short-term window to buy the dip in US stocks, according to Scott Rubner at Goldman Sachs Group Inc.
“I am turning tactically bullish equities on August 30th,” Rubner wrotes in a note to clients Monday. “This will be my last bearish equity markets call for August as we are ending the worst of the equity supply and demand mismatch for August.”
A historical analysis of previous growth scares suggests that stock correlations and volatility will “will only gradually recede back to ‘normal,’” according to Goldman Sachs Group Inc. strategists led by David Kostin.
If economic worries abate, “then the recent sell-off represents an opportunity to buy stocks with healthy fundamentals at valuation discounts,” they wrote.
The risk-reward for stock markets remains mixed over the summer months against the backdrop of weakening business activity and negative earnings revisions, according to JPMorgan Chase & Co strategists led by Mislav Matejka.
“Fed will start cutting, but this might not drive a sustained leg higher, as the cuts might be seen as reactive, and behind the curve,” they wrote.
A double whammy of economic uncertainty and a weak period for corporate earnings forecasts is likely to cap stock market gains, according to Morgan Stanley’s Michael Wilson.
The strategist — among the most notable bearish voices on US equities until last year — said he expects the S&P 500 to trade in a range of 5,000 to 5,400 points as macroeconomic data flash no clear signals over the short term. The upper end of that range implies gains of just 1% from current levels, while the lower end would mean a decline of 6.4%.
In addition, analysts’ profit downgrades are expected to outnumber upgrades in line with seasonal weakness, “which is one reason why the third quarter is typically the most challenging for stocks,” Wilson wrote in a note.
Corporate Highlights:
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B. Riley Financial Inc. faces a widening US investigation into whether it gave investors an accurate picture of its financial health amid a string of losses and a sagging stock price.
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JetBlue Airways Corp. has kicked off a $2.75 billion bond-and-loan sale backed by its loyalty program as the carrier seeks to raise reserves and fund general corporate purposes.
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Bank of Nova Scotia agreed to buy a minority stake in KeyCorp, which was among the US regional banks hit hardest in last year’s tumult, for about $2.8 billion as part of a focus on North America.
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Vestas Wind Systems A/S issued a profit warning for its full-year results in a blow to the company’s effort to turnaround steep losses in recent years.
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Starboard Value, an investment firm with a history of taking activist positions in companies, has a stake in Starbucks Corp., according to a report.
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Hawaiian Electric Industries Inc. pegged losses from estimated accrual of liabilities stemming from one of the worst wildfires in US history at $1.7 billion and issued a going-concern warning.
Key events this week:
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Germany ZEW survey expectations, Tuesday
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US PPI, Tuesday
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Fed’s Raphael Bostic speaks, Tuesday
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Eurozone GDP, industrial production, Wednesday
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US CPI, Wednesday
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China home prices, retail sales, industrial production, Thursday
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US initial jobless claims, retail sales, industrial production, Thursday
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Fed’s Alberto Musalem and Patrick Harker speak, Thursday
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US housing starts, University of Michigan consumer sentiment, Friday
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Fed’s Austan Goolsbee speaks, Friday
Some of the main moves in markets:
Stocks
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The S&P 500 rose 0.1% as of 9:38 a.m. New York time
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The Nasdaq 100 rose 0.2%
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The Dow Jones Industrial Average was little changed
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The Stoxx Europe 600 rose 0.1%
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The MSCI World Index was little changed
Currencies
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The Bloomberg Dollar Spot Index rose 0.1%
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The euro rose 0.1% to $1.0928
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The British pound was little changed at $1.2773
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The Japanese yen fell 1% to 148.14 per dollar
Cryptocurrencies
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Bitcoin rose 1.4% to $59,364.59
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Ether rose 5% to $2,685.61
Bonds
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The yield on 10-year Treasuries advanced two basis points to 3.96%
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Germany’s 10-year yield advanced three basis points to 2.25%
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Britain’s 10-year yield advanced one basis point to 3.96%
Commodities
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West Texas Intermediate crude rose 1.7% to $78.13 a barrel
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Spot gold rose 0.8% to $2,450.81 an ounce
This story was produced with the assistance of Bloomberg Automation.
–With assistance from John Viljoen and Matthew Burgess.
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