Value stocks lag growth equities after U.S. CPI inflation report

A reading from the Labor Department’s consumer-price index on Wednesday showed the rate of inflation in April eased to 4.9% on a year-over-year basis, falling below 5% for the first time in two years. The U.S. stock market initially reacted positively to the inflation report, with major indexes climbing at the open. 

“There’s nothing in the CPI data this morning that surprised us,” said Philip Orlando, chief equity market strategist at Federated Hermes, in a phone interview Wednesday. “What surprised me was the equity market’s initial reaction, which was strongly bullish.”

The headline CPI numbers on inflation were “essentially flat,” he said. The pace of inflation eased to a year-over-year rate of 4.9% in April, from 5% in March. So-called core inflation, which excludes energy and food prices, cooled slightly to a rate of 5.5% over the past 12 months, from 5.6% in March.

Inflation at those levels should keep the Fed engaged in its battle to bring down the high cost of living in the U.S., according to Orlando, who noted both headline and core CPI rose on a month-over-month basis in April.

In his view, the central bank may pause its interest rate hikes at its June policy meeting, and then potentially hold them at the current level until the middle of next year. 

The Fed has been battling stubbornly high inflation by rapidly raising rates over the past year. Although some investors have been anticipating rate cuts later this year, Orlando disagrees, saying the stock market will probably have to readjust those expectations. 

“The Fed is telling you they’re not going to cut interest rates and the market doesn’t believe it,” he said. Orlando said the stock market may be set up for a decline, partly because he’s expecting a decline in corporate earnings.

“We think that corporate-earnings estimates are too high,“ he said. “The next six months could be a little rocky.”

U.S. stocks closed mostly higher Wednesday, with the S&P 500
SPX,
-0.16%
up 0.4%, the technology-heavy Nasdaq Composite
COMP,
-0.35%
climbing 1% and the Dow Jones Industrial Average
DJIA,
-0.03%
slipping 0.1%, according to Dow Jones Market Data.

From an asset allocation standpoint, Orlando favors playing defense, citing an overweight to cash and to Treasurys. 

Within equities, though, he pointed to an overweight in “defensive stocks, which we would define as domestic large- and small-cap value,” he said. Orlando also cited a preference for international equities in developed and emerging markets.

Meanwhile, the Vanguard Small-Cap Value ETF
VBR,
+0.03%
closed around 0.1% lower Wednesday, trailing the 0.5% rise for the Vanguard Small-Cap Growth ETF
VBK,
-0.17%,
FactSet data show.