Highlights:
- Hotter inflation and stronger economic data suggest “higher for longer” Fed policy, driving interest rates higher.
- Geopolitical events led to stock correction on uncertainty, that has quieted down.
- This month, the earnings season started off uncertain on ASML, TSM, and Jamie Dimon comments, but end on a positive note from TXN, MSFT, GOOG, and META (indirectly).
- Technical analysis shows we don’t have enough evidence to call this a dip or a correction, but a rally has resulted to end the month on a positive note and is testing key resistance levels.
Many investors are left wondering if the stock correction in April will be a short-term dip or correction. To understand if this is just a short-term dip or something more meaningful, we must look at the technical and fundamental backdrop that is moving sentiment. This month’s big picture article will look at the reasons for the selling pressure and decide if the underlying fundamentals are still intact.
What Drove Selling?
Multiple factors contributed to the market weakness this past month. First, higher inflation reports reduced the likelihood of a rate cut in June to practically zero and led to an increase in interest rates. Secondly, geopolitical tensions surrounding attacks between Iran and Israel raised concerns the conflict could escalate, causing oil prices to climb. Additionally, April marked the beginning of a new quarter following a strong start to the year, with the S&P 500 gaining 10.16% by the end of the first quarter. Consequently, the start of April saw some market decline due to rebalancing and increased sensitivity to valuations as the earnings season commenced.
Inflation and Higher Rates
To kick off the month of April, the 10-year Treasury yield rose 12 basis points to 4.33% on April 1st. The previous Friday was the release of the February Personal Spending and Income report, on the day the market was closed for Good Friday. The report showed that spending outpaced income, jumping 0.8% versus income up 0.3% which indicates consumers are spending out of savings. The PCE Price Index was up 0.3% with the year-over-year rate of change up 2.5%. Core PCE Price Index was up 0.3% and up 2.8% versus the year prior showing the sticky nature of inflation. On April 1st, the ISM Manufacturing Index rose to 50.3 in March, the first time above 50 since September 2022 which also helped interest rates rise.
The Consumer Price Index (CPI) is not the Fed’s preferred inflation indicator (which is the Core CPE Price Index), but it is one of many inflation indicators investors and the Fed monitor. The data for March was released on April 10 and indicated growth of 0.4% for the headline and core monthly change. On a year-over-year basis, inflation accelerated from 3.2% in February to 3.5% while core CPI was up 3.8% for the second consecutive month. The key takeaway from the report is that the hotter inflation data would make it harder for the Fed to consider a pivot away from its restrictive policy and remain “higher for longer”. The 10-year Treasury yield surged 19 basis points on the day to 4.56% from 4.35% the previous day.
There have been several Fed officials weighing in on why the Fed should stay higher for longer and many have turned hawkish again. Part of the heavy losses on April 4th was attributed to Minneapolis Fed President Kashkari who said it is possible the Fed doesn’t cut rates if there is no progress on inflation. April 16th, Fed Chairman Jerome Powell at a panel had said that restrictive policy needs more time to work since recent data has not shown progress on the inflation front. The comments largely supported what investors had already surmised from the inflation data for themselves. The CME FedWatch Tool indicates an 11% probability of a rate cut in June, which had a probability of 55% or a coin toss a month ago. As of April 29th, the probability of a rate cut now stems at 43-44% for a rate cut in either September or November based on the CME FedWatch Tool which tracks the 30-day Fed Funds futures pricing data.
Geopolitical Tension
For a while in April, it seemed that Israel and Iran were in the news daily. Each country was making limited drone and missile strikes at the other; however, concerns were rising that one of these attacks could have led to an all-out conflict, possibly drawing in other parties. Before April, the last known airstrike was conducted by the U.S. in February against an Iranian-aligned militant group that killed three U.S. service members at a Jordanian base in January. The first week of April kicked off with an airstrike at an Iranian Embassy compound in Syria that killed two senior members and five officers. The U.S. denied involvement suggesting it was an Israeli strike. Iran’s supreme leader vowed retaliation, stating it would be carried out by Iranian forces. The U.S. had already shot done drone attacks following those remarks in Syria. Oil rose from $83 a barrel to $87 on the week.
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On Friday, April 12th, news was out with warnings from the U.S. that there was likely to be an imminent attack by Iran over the weekend. That weekend it was reported more than 300 drones and missiles were launched; however, the attacks scored minor damage due to most being shot down by the U.S. or Israel. The following Monday, Israel Chief of Staff vowed to respond to the attacks which sent stocks tumbling down. Stocks retreated for four more consecutive days that week and ultimately bottomed on Friday when Israel made a calculated airstrike on an airbase close to Iran’s nuclear facilities. The attack allowed both to save-face and the news has been quiet on the geopolitical front since. Oil prices have retreated since April 5th at a close of $86.91 and recently bottomed on April 22nd at $81.23. The trend has been higher lows and higher highs since the December low. While strikes were seemingly on a weekly basis between the two parties, an all-out conflict has been avoided for now and it doesn’t appear we have had any concerns in the news that have resulted in negative sentiment for stocks since April 19th.
A New Quarter and New Earnings Season
It's a new earnings season, kicked off by the financials on April 12th. Usually, this period of time is marked by weak performance in stocks as companies with large buyback programs stop buying ahead of their earnings releases. This period of time is typically two weeks prior to the quarter end as well as 48 hours after earnings are released. It’s expected that S&P 500 earnings will have grown by 7% after all companies have reported according to FactSet.
There have been some key earnings announcements so far this season. The first of which was from JP Morgan’s CEO, Jamie Dimon, on day 1 of the earnings season. He said “many economic indicators continue to be favorable…we remain alert to a number of significant uncertain forces…persistent inflationary pressures, which may likely continue.” He also said that the bank is seeing cracks in subprime auto loans and that market pricing (in stocks) is likely “too happy” and the chance of a bad outcome is “higher than other people think”. Finally, he cited that Russia’s war with Ukraine is more important than the debate on a U.S. soft landing suggesting that world conflicts could be detrimental for the global economy if oil and gas prices rise too high. Recent comments from economist Francois Trahan suggest that oil hasn’t risen high enough yet for that to happen.
Semiconductors and their earnings announcements have been key with the wave of investment into AI capability and technology infrastructure spending. Kicking things off last month were earnings announcements from ASML and Taiwan Semiconductor. ASML shares fell 7.1% on missing its sales forecast and for guiding below the consensus on the current quarter’s estimates. ASML’s machinery net bookings were down 4% year-over-year. The company’s machines are required to manufacture chips made by Samsung, Taiwan Semiconductor, and Intel so it’s an important read on the demand for chips since these companies have been said to be ramping up production given the support from the U.S. CHIPS and Science Act. There are also the unknown implications from export restrictions to China which the company has yet to address these issues in its reports.
Taiwan Semiconductor Manufacturing (TSM) was down significantly post-earnings release on somber comments about the industry and with its growth modification of the overall chip forecast for 2024 from “more than 10%” to just “10% growth”. Growth for Taiwan Semi slowed in both the smartphone, automotive, and internet of things segments. The weaker outlook for semiconductors from both ASML and Taiwan Semi took some of the froth out of chip stocks the week they announced with the Philadelphia Semiconductor Index down 9% for the week and AI-champion, Nvidia, down more than 12% for the week.
Last week’s earnings announcements from Texas Instruments, Meta Platforms, Microsoft, and Alphabet created a bullish rebound for tech. Texas Instruments said some industrial customers are nearing the end of an inventory correction cycle that led to a rally in chip stocks on the day. While Meta’s earnings announcement and communication it will be increasing its capex guidance on the year from $30-$37 billion to $35-$40 billion spells increased costs for the company and lower margins, it spells higher demand for chipmakers. While stocks were down initially on the news and due to the poor GDP print, they rebounded nicely with the idea of more chip spending. Last week, Microsoft and Alphabet were able to show how the companies are realizing better profitability from AI adoption in cloud income and in advertising for Alphabet.
Is Sentiment Turning Bearish?
After a six-day consecutive decline in mid-April, stocks have been rebounding, with five out of the last six trading days showing gains as of Monday, April 29th. This rally reflects a "buy-the-dip" reaction and positive responses to earnings from key players mentioned earlier. Looking ahead, this week will be pivotal, with nearly a third of the S&P 500 companies reporting earnings, including Amazon on Tuesday and Apple on Thursday. Moreover, significant events like the Fed's policy announcement and press conference on Wednesday with no rate cuts, coupled with key economic reports such as the ISM Manufacturing results on May 1st and Services on May 3rd, along with ongoing jobs data culminating in the nonfarm payroll report on Friday, are expected to serve as major catalysts. While any of these events could reshape market sentiment, the prevailing narrative remains bullish following the recent rally.
Monday marked a crucial technical test for the S&P 500, which reached a high of 5123, just shy of its 50-day moving average currently at 5125. Breaking above this level, along with surpassing support in the 5140-5150 range from earlier in the month, would significantly improve the outlook. Conversely, a failure to breach these key areas could prompt a retest of the April lows.
The trajectory of interest rates is a critical factor for investors. If rates are rising due to economic strength, investors can remain confident. However, if rates are driven by inflation fears, similar to what occurred in Q3 of 2023, it could pose a larger problem for stocks. Currently, rates have risen for both reasons but have stabilized over the past two weeks around 4.65% on the 10-year Treasury, peaking briefly after a recent GDP print that hinted at stagflation.
Looking at geopolitical concerns, Jamie Dimon's view is prudent. Potential conflicts and trade disputes are significant catalysts to monitor. President Biden's recent bill allocating $95 billion in funds to Ukraine, Israel, and Taiwan raises concerns given our country's substantial debt and budget deficit. Although these issues could escalate into larger conflicts, they remain speculative and not immediate market drivers. However, any deepening conflict would likely have a bearish impact on stock markets.
On the trade front, global free trade is shifting towards regional trade for political reasons. The U.S. has been restricting AI chip shipments to China for a year, and there are indications that such measures could intensify, with China reciprocating by banning certain technologies. Notably, China has implemented guidelines banning Intel and AMD CPUs, as well as Microsoft Windows, from government PCs and servers this year. Moreover, recent foreign aid legislation included a TikTok ban, possibly in response to China's restrictions on U.S. social media. While the full impact of these trade restrictions on earnings remains unclear, the trend indicates increasing restrictions and less open trade, a theme that has persisted into 2024.
So Is it a Dip or Correction?
In wrapping up the selling activity over the prior month, it seems clear that inflation and positive economic data played a central role, leading bond and stock investors to adjust to the Federal Reserve's "higher for longer" policy stance. Geopolitical uncertainties also weighed heavily, especially with ongoing strikes involving the U.S., Israel, and Iran, raising fears of potential escalation into a full-scale conflict. Additionally, early earnings reports from companies like ASML and Taiwan Semiconductor, along with macro remarks from JP Morgan's Jamie Dimon, aimed to temper the overheated valuations of stocks and semiconductor shares following the strong first-quarter trading period.
Stocks have rallied to end the month on a stronger note, suggesting the April correction may just be a dip. Earnings at the end of last week from Texas Instruments, Microsoft, Alphabet, and Meta (indirectly) gave a different perspective on the chip market than from ASML and Taiwan Semiconductor that had a glass-is-half-full effect when looking at the industry.
The 50-day moving average rebuffed the rally Monday with more resistance set above, that will be key to monitor and will give us our technical cues. In technical analysis, a correction is typically three waves with one down, a rally, and the final wave down. From a technical standpoint, it’s too soon to confirm one way or the other if this was a dip or the beginning of a correction based on the three-wave principle and no evidence of a trend reversal (lower high and a lower low). I’ve laid out enough evidence for the causes of April’s correction in stocks to suggest that there hasn’t been enough evidence on a geopolitical or from an economic and monetary policy front to suggest a more meaningful correction is in the cards.
This week stands to be a week of important news items I’ll be sure to cover in this week’s wrap up report. Any one of them could confirm the April dip was a buying opportunity or turn the dip into something of a correction with another leg down in May. This week will be pivotal in concluding the question: dip or correction.
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