Will Stocks Bounce This Week?

The stock market could bounce this week, after it held a key support level (200-day moving average) on Friday.  A consensus 0.2% m/m (or lower) print for the January Core CPI (due Wednesday) is probably critical for this to happen.  Such a print is not guaranteed, however.  And, a retest of the key support level before then is possible if the market turns cautious ahead of the release.  The January CPI also is important with regard to the longer-term question whether the market needs to remain in a downtrend to "crowd out" fiscal stimulus, as discussed below. 

This coming week's report on January CPI will be critical for the market.  A consensus print of a near-trend 0.2% m/m for the Core CPI would be a relief for stocks, particularly since the y/y would fall to 1.6-1.7% from 1.8%.   But, a higher print cannot be ruled out.  The CPI always risks printing high this month because start-of-year price hikes may not be fully offset by seasonal factors.  This year, there also is the risk that it could show the pass-through of higher oil prices.  And, the end of holiday-related discounting could result in a bounce in apparel prices.  But, a couple of components with large price increases in November and December -- motor vehicles and medical commodities -- could ease this month.  

A downtrend in the stock market is consistent with the idea that the financial markets need to move in ways that, on balance, "crowd out" private spending to make room for the boost from fiscal stimulus.   The latest budget deal, with the $300 Bn government spending increase, adds to the stimulus of the tax cut.  And, the potential monies needed for the "wall" or infra-structure construction hover above the stimulus already legislated.

From a macroeconomic perspective, there are three outcomes that could end the stock market's downtrend -- /1/ a slowdown in economic growth to the 1.5-2.0% range, consistent with the longer-term trend, /2/ an increase in the economy's potential growth rate, either through a ratcheting up of productivity growth or labor force participation, or /3/ steady to lower inflation, implying that the unemployment rate can fall further without being inflationary.   So far, only the 3rd outcome is in play as a near-term possibility, and this week's January CPI report is important in this regard.  The 2nd outcome is questionable, but can't be ruled out.   Additional evidence is a couple of months away.  The 1st outcome is yet to be seen in the data.

There are almost no signs yet of a slowdown in economic growth.  Manufacturing and non-manufacturing surveys were strong in January.  And, the Unemployment Claims data remain low.  The New York and Atlanta Fed models' early projections are 3.4-4.0% (q/q, saar) for Q118 Real GDP Growth.   The only hint of a slowdown to trend is the steady 4.1% Unemployment Rate since September.  This element of the January Employment Report was ignored by the markets, but it could be important.  The Unemployment Rate needs stay at 4.1% into the Spring to indicate the economy is growing near trend.

For stocks, the goal of a slowdown means that strong US economic data are "bad" while weak data are "good."  It's instructive that data releases were strong on the two worst market days last week -- Monday (Non-Mfg ISM) and Thursday (Claims).  Consensus looks for decently strong prints for January Retail Sales, February Phil Fed Mfg Index, and January Industrial Production in the coming week.

The latest data also don't suggest a pickup in trend productivity growth or labor force participation.   The y/y increase in Nonfarm Productivity was 1.1% in Q417, within the range seen in the past few years.  To be sure, a bounce in productivity growth is conceivable for Q118, as Total Hours Worked fell in January and early estimates of Q118 Real GDP Growth are strong.  If so, the possibility of a higher trend will be back in play -- but this won't be known for a few months.  The Labor Force Participation Rate has been fairly steady since 2014.  The next observation will be with the February Employment Report on March 2.

Although market commentators have talked up higher inflation as a reason for last week's market sell-off, the evidence is far from conclusive.  The jump in January's Average Hourly Earnings could have resulted from a compositional shift in jobs or hours worked -- a possibility mentioned by NY Fed President Dudley in a Bloomberg interview -- and could reverse in February.   To the extent that the pickup in AHE reflected the sharing of the corporate tax cut with low-wage workers by some large companies, it should not be passed through to higher prices.  The two broadest measures of labor costs -- the Employment Cost Index and Compensation/Hour -- were benign in Q417.