Joey Solitro
Markets closed mixed Thursday as the first decrease in inflation in almost two years raised bets that the Federal Reserve could become more aggressive in its easing campaign. The news unexpectedly sent market participants out of red-hot mega-caps and into riskier parts of the market.
The big news of the day was the June reading on consumer inflation, which showed that prices declined for the first time since 2022. Indeed, headline June CPI declined 0.1% month-over-month, or the first drop in 23 months, according to the U.S. Bureau of Labor Statistics.
Economists forecast inflation to increase by 0.1% vs May. On an annual basis, CPI rose 3.0% in June – down from 3.4% the prior month – to beat estimates for a 3.1% gain.
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Core CPI, which excludes food and energy costs, likewise surprised to the downside, rising just 0.1% in June vs the previous month. Forecasts called for a 0.2% increase.
"Shelter, which comprises the largest portion of CPI, decelerated meaningfully from 0.4% in May and was responsible for the downside beat," says José Torres, senior economist at Interactive Brokers.
Sticky inflation readings have been a stumbling block for the Federal Reserve as it seeks to achieve its long-term target of 2%. Although the June CPI report is dovish for rate policy, a quarter-point cut at the next Fed meeting is highly unlikely, experts say.
However, markets are now pricing in looser policy than the central bank signaled at its June meeting.
As of July 11, interest rate traders assigned an 86% probability to the FOMC enacting its first quarter-point cut to the federal funds rate in September, up from 70% a day ago, according to CME Group's FedWatch Tool.
Markets were mixed on the dovish inflation data, however. "The reaction in equities is shocking, as investors clamor for small caps while ditching the popular tech trade," Torres says.
The tech-heavy Nasdaq Composite – fresh off yesterday's record high – plunged almost 2% to 18,283. The broader S&P 500, also coming off a record close, shed 0.9% to end at 5,584. The blue-chip Dow Jones Industrial Average added less than 0.1% to finish at 39,753.
The small-cap benchmark Russell 2000, however, rallied more than 3.7%. (See more on small-cap stocks below.)
Stocks making moves
Delta Air Lines (DAL, -3.9%) stock fell sharply after the air carrier satisfied analysts' expectations for its second quarter but provided a soft outlook for the third quarter.
In the three months ended June 30, Delta's operating revenue increased 6.9% year-over-year to $16.7 billion while its revenue per available seat mile decreased 1.2% to 22.3 cents. Its earnings per share (EPS) decreased 11.9% to $2.36 from the year-ago period.
The results satisfied Wall Street's expectations, but sentiment turned negative toward Delta after the company provided the outlook for its third quarter. Delta now anticipates total revenue growth in the range of 2% to 4% and earnings per share in the range of $1.70 to $2.00, which came up short of analysts' estimate of $2.05 per share.
PepsiCo (PEP, +0.2%) reported mixed results for its second quarter and revised its full-year revenue outlook. The snack food and beverage giant's revenue increased 0.8% year-over-year to $22.5 billion as volumes declined 4% and 3%, respectively, in its Frito-Lay and PepsiCo Beverages segments in North America. Its earnings per share (EPS) increased 9.1% to $2.28 from the year-ago period.
The results were mixed compared with analysts' expectations. Wall Street was anticipating revenue of $22.6 billion and earnings of $2.16 per share.
As a result of its soft performance in the first half, PepsiCo revised its full-year revenue guidance. It now expects organic revenue growth of 4% versus its previous guidance of growth of at least 4%. It reiterated its expectation for core EPS of at least $8.15, an increase of 7% from the prior year.
Costco (COST, -4.3%) is hiking membership fees for the first time since 2017. The warehouse club is raising its annual membership fees by $5 for non-executives and by $10 for executives in the United States and Canada.
The change is effective September 1 and will impact around 52 million memberships, Costco said in a statement. Costco has traditionally raised its membership prices by $5 to $10 every five-and-a-half years, so the latest increase should not come as a shock to members since the last increase was in June 2017.
Additionally, management has been clear about its plans to raise membership fees. On its conference calls in December 2023 and March of this year, Costco's chief financial officer said the fee increase was a matter of "when, not if."
Small caps rally
While select Magnificent 7 stocks such as Nvidia (NVDA), Apple (AAPL) and Microsoft (MSFT) have driven the majority of the market's gains in the bull market, small caps – which tend to be more sensitive to the economic cycle and interest rates – have been a dud.
Indeed, the small-cap benchmark Russell 2000 – struggling to stay positive for months – was slightly negative as we closed out the first half.
"We think the fact that higher rates are putting more pressure on small companies' profitability is driving the performance gap," writes Liz Ann Sonders, chief investment strategist at Charles Schwab.
That's why Thursday's action was potentially interesting. The Russell 2000 rallied sharply while the Mag-7-heavy Nasdaq-100 tumbled 2.1%.
If interest rates come down farther and faster than previously thought, that could make the risk-reward scenario for the best small-cap stocks to buy much more compelling.
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