Can Record-High Stocks Market Hold Its Ground?

This week's upcoming inflation reports carry significant weight as they provide a clearer insight into the interest rate trajectory ahead of the imminent Fed policy meeting. With stock markets soaring to unprecedented highs, investors are treading cautiously, wary of potential repercussions.

Let's delve into the key components:

CPI Report

Scheduled for release on Tuesday, the February Consumer Price Index (CPI) and the Producer Price Index (PPI) due on Thursday have the potential to unsettle equities if they reveal a hotter-than-anticipated inflationary trend. Such reports would likely delay the expected timeline for interest rate cuts, currently projected to commence in June with a quarter-percentage point reduction according to the CME FedWatch Tool.

The anticipation of lower interest rates, coupled with the fervour surrounding artificial intelligence, has been a driving force behind the stock market's surge since late 2023. The accommodative stance of the Fed has played a pivotal role in propelling this upward trajectory, particularly evident since October of the previous year. Consequently, a surge in inflation could pose a significant challenge to market sentiment.

This week's consumer inflation data follows January's unexpectedly robust report, which dampened investor optimism regarding the ease of achieving the Fed's 2% inflation target. Economists forecast a monthly increase of 0.4%, up from the previous 0.3%, while the year-over-year gain is expected to remain unchanged at 3.1%.

The Core CPI, excluding volatile food and energy prices, is anticipated to reflect a slight moderation in inflationary pressures. Projections suggest a monthly increase of 0.3% and a year-over-year gain of 3.8%, down from January's respective figures of 0.4% and 3.9%.

Of particular concern to Wall Street are sectors where inflation has exhibited stubborn resilience. The previous CPI report highlighted significant rise in medical expenses, transportation costs, airline fares, and notably, dining-out expenses. Additionally, shelter prices, including escalating home prices due to demand outstripping supply, remain a focal point of market scrutiny.

Record Highs in Stocks Fuel Caution

The remarkable ascent of momentum stocks in recent weeks has provided a compelling reason to anticipate a shift in the market's dynamics. While Friday's sharp reversal in Nvidia shares, fluctuating from a 5% gain to a 5% loss within hours, maybe an isolated event, it serves as a stark reminder of the volatility inherent in momentum-driven markets.

Nvidia, a standout performer in the AI sector, has been emblematic of this exuberant trend, witnessing a staggering $1.5 trillion increase in market value over the past year. Despite reassurances stemming from a modest decline in its valuation and robust revenue and profit projections, concerns loom regarding the sustainability of its growth trajectory.

Traders are grappling with the challenge of gauging the sustainability of the current macroeconomic environment about future returns. While the market exhibits characteristics reminiscent of a mid-cycle phase, it is not without risks. Currently priced for ambitious annual free-cash-flow growth of 11.6% over the next five years, the market's valuation may soon confront the reality of achieving such lofty expectations.

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Fullerton Markets Research Team
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