The prospect of “peak inflation” propelled stocks higher Friday, extending a rally that has enabled the S&P 500 index to close in positive territory for the fourth consecutive week. Notably, S&P 500 index broke above a resistance level of 4,231 which has been closely-watched as a metric that affirms the bottom may have been reached.
On Friday the Dow Jones Industrial Average rose 424.38 points, or 1.27%, to end Friday’s session at 33,761.05. The S&P 500 gained 72.88 points, or 1.73%, to finish at 4,280.15. Of the eleven S&P sectors, ten closed higher with which has been dominated by growth stocks. The materials sector continues to be a notable outperformed, just ahead of technology stocks. The energy sector was the only group in the red Friday.
The tech heavy Nasdaq Composite, which has been brutally punished during the selloff continued its resurgence, jumping 267.27 points, or 2.09%, to end at 13,047.19. As it stands, all of the major averages have gained about 2.5% for the week. What sparked Friday’s rally? Inflation is seemingly being tamed, evidenced by the August consumer sentiment index which rose more than expected to 55.1, according to University of Michigan's preliminary measure. This placed the one-year inflation expectations to 5%, a slight dip from 5.2%.
The market's main concern for most of the year and throughout the selloff has had to do with the direction of the overall economy: Namely, can the Fed control inflation in a manner that prevents a recession? Friday’s University of Michigan's preliminary measure, along with the consumer price index (CPI) numbers this week suggests things are moving the right direction. The CPI received on Thursday was flat from June to July, thanks in large part to falling gas prices. Meanwhile, the produce price increase showed a surprise decline.
All of these are positive signs that “peak inflation” is more than a dream. That said, there is still the question of what the Federal Reserve will do at their policy meeting in September. But the inflation metrics, at least for now, would make it harder for them to maintain their hawkish stance. In the meantime, as it relates to stocks, when factoring the lowered revenue and earnings estimates for the rest of the year, stocks have now regained what many analysts call “reasonable” valuation levels. The question is, which value stocks, or even sectors, can sustain the rally we are in?
While it's premature to raise the “all clear” flag, there are still several under-appreciated or beaten down stocks that presents buying opportunities, many of which can give portfolios an immediate boost. Investors with a long-term view, even during this resurgence, can still do well staying invested.
On the earnings front, here are some names I’ll be watching this week.
Home Depot (HD) - Reports before the open, Tuesday, Aug. 16
Wall Street expects Home Depot to earn $4.95 per share on revenue of $43.37 billion. This compares to the year-ago quarter when earnings were $4.53 per share on revenue of $41.12 billion.
What to watch: Home Depot has been a strong Dow performer over the past two years, but so far in 2022, the company has been adversely impacted by soaring interest rates which have helped to slow the housing market. If that weren't bad enough, the company's gross margins have been shrinking because of higher inflation rates. Higher input costs and weakening consumer demand has caused margin erosion within this business. These have had a negative impact on Home Depot stock, which has fallen 26% year to date, trailing the 13% decline in the S&P 500 index. Interest rate hiking cycles have historically hampered home improvement stocks. That said, there is still confidence in the housing market, which has held up relatively well despite rising mortgage rates. From an execution perspective, the home improvement giant has established a strong track record for beating consensus estimates, surpassing both revenue and profit estimates in the last ten quarters. Nevertheless, the company’s guidance on Tuesday will be a key indicator of where the management believes the housing market and consumer spending will be in the next several quarters.
Walmart (WMT) - Reports before the open, Tuesday, Aug. 16
Wall Street expects Walmart to earn $1.60 per share on revenue of $149.78 billion. This compares to the year-ago quarter when earnings came to $1.78 per share on revenue of $139.87 billion.
What to watch: The retail sector has been under pressure over the past several months as investors digest the impact of rising inflation at a time when the Federal Reserve is also raising interest rates. It’s for this reason, among others, Walmart is expected to deliver a year-over-year decline in earnings on higher revenues when it reports results. The world's largest retailer has not been immune to higher input costs and supply chain disruptions. Since the start of the year, the company has slashed its full year earnings guidance by a dollar. The result of lower earnings estimates have impacted the stock price which has fallen 20% from its 52-week highs of around $160. The stock is now down 11% over the past year, trailing the 7% decline in the S&P 500 index. Although rate hikes were not a surprise, investors are nonetheless weighing the potential impact on consumer spending, and perhaps worse, a recession. The company on Tuesday will need to talk positively about its growth prospects and the macro impact on its customers.
Target (TGT) - Reports before the open, Wednesday, Aug. 17
Wall Street expects Target to earn 72 cents per share on revenue of $26.1 billion. This compares to the year-ago quarter when earnings came to $3.64 per share on revenue of $25.16 billion.
What to watch: How strong is the consumer? That’s what investors are wondering before deciding to buy shares of Target which plunged some 25% in a single day after the company last-reported its earnings results. Aside from inflationary pressures and excess inventory, Target suffered from declining operating income as well as earnings per share. The inventory issue was a misfire, though well-intended. As a way to mitigate supply chain issues, the company ordered more merchandise than it needed. When these items have not sold, Target was forced to aggressively discount them so they can move — something that has yielded lower margins or outright losses. Analysts have since trimmed the company’s earnings estimates which has also been reflected in the stock price which has fallen 50% from its 52-week highs of around $268. The stock is now down 37% over the past year, trailing the 7% decline in the S&P 500 index. But the company has taken steps to address these operating concerns, including plans to reduce freight and transportation costs. Tt will need strong top- and bottom-line results and upside guidance to regain investor confidence.
Cisco (CSCO) - Reports after the close, Wednesday, Aug. 17
Wall Street expects Cisco to earn 82 cents per share on revenue of $12.78 billion. This compares to the year-ago quarter when earnings came to 84 cents per share on revenue of $13.13 billion.
What to watch: When will Cisco finally turn the corner? As with the rest of the tech sector, the company has been punished over the past six months, losing some 30% of tis value. The tech giant produces high quality network equipment that its customers rely on, but investors aren’t so sure that reliance it worth the current stock price. The company has been working to transition 50% of its business model beyond legacy hardware product sales towards a software subscription model that is more sustainable and recurring. However, the transition has been volatile. The company's revenue growth over the past few years hasn’t been strong enough to entice investors to be patient. That said, the company still generates significant free cash flow, in addition to an attractive yield of almost 3%. What’s more, the company’s strong cash flow generation is allowing the business to return excess cash to shareholders in the form of buybacks. In the first nine months of this current fiscal year, about $10 billion has been returned to shareholders. The company’s business is healthy enough to withstand the revenue drought. But for any of that to matter, the company on Wednesday must show consistent growth in its pivot towards software and subscription businesses as it scales down the legacy hardware segments.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.