DAILY STRATEGY: Main Point – The readthrough to core PCE from CPI is ~0.2% (HERE); That is on the dovish side and a positive for risk assets, all things equal. It was not dovish enough to eliminate the risk of higher inflation and associated need to tighten financial conditions*. But good enough to keep the risk of financial conditions tightening in the background relative to fundamentals through earnings. With lower financial conditions tighten risk through earnings, correlations are biased to stay low, and fundamentals should be a large part of driving returns.
Earnings Momentum, Earnings Growth and Price Momentum (these groups are mostly AI driven) should have tailwinds through EPS season. We don’t have an edge on what the companies will report or signal about the future of AI demand**, but earnings expectations for all the groups, particularly Price Momentum, are strong (HERE) and the recent beat rates have been atypically strong (HERE).
Caveat, for a July hike to be back on the table and financial conditions tightening risk to increase again, would take a supremely hot set of PPI data today. That is possible, although most economists think it unlikely. We will be back after the PPI.
Additionally, the recent increase in 2yr and 10yr yields has been a headwind for AI driven stocks (HERE). The correlation between 10yr yields and price momentum has been increasingly negative. The threat of financial conditions is clearly not the only thing driving the group, but to the extent that UST yields are more range bound going forward, which is our call post the CPI data, that headwind will fade. In short, the AI driven baskets have had a significant correction, they face less macro headwinds through EPS season and fundamentals are supportive.
The percentage of stocks trading above their 50day moving average in the Morgan Stanley Broad AI index (MSXXAI Index) is below the 25th %tile. Forward returns are stronger than normal for this basket when it has been oversold in the past.
*FYI, investor attention has turned to incremental news on capex plans for earnings. We are running a 2 question survey on this to help investors mark to market expectations – link HERE.
**20bps is only 1bp below the 21 that CPCE needs to average to end the year at the Fed’s latest forecast (HERE). The current strength in nominal demand muddles the forward outlook for inflation, and Warsh’s focus on inflation is surprisingly hawkish. Warsh made it clear that his view is NOT “mission accomplished” after yesterday’s data (HERE).
Charts…
The correlation between 10yr yields and the Price Momentum Factor has been increasingly negative.
Correlations typically decline during EPS season.
Correlations tend to fall within AI baskets too.
The Price Momentum Factor NTM EPS growth is unusually strong.
The drawdown in the price momentum factor has been severe.
The percentage of stocks trading above their 50day moving average in the Morgan Stanley Broad AI index is below the 25th%tile. Forward returns are stronger than normal for this basket when it has been oversold in the past.
