Cooling Inflation is Good News, but Earnings Will Be the Real Test

with Adam Phillips, Managing Director, Investments 

Last week's inflation report gave investors some encouraging news. Inflation came in slightly cooler than expected, easing concerns that the Federal Reserve may feel the need to become more aggressive with interest rates.

Consumer prices fell 0.4% from the previous month, largely because energy prices dropped nearly 6%. On a year-over-year basis, inflation is still running at 3.5%, well above the Fed's 2% target.

While the report was encouraging, I don't think we're ready to declare victory over inflation just yet.

One risk we're watching is the ongoing tension in the Middle East. If oil prices begin moving higher again, some of the benefit we've seen from lower energy prices could disappear.

We're also keeping an eye on another source of inflation pressure. As companies continue investing heavily in artificial intelligence, software and technology costs continue to climb. Computer software and accessories are now more than 17% higher than they were a year ago. It's a reminder that inflation doesn't disappear overnight, and the source of price pressure can shift from one part of the economy to another.

Why It Matters

With earnings season underway, investors are beginning to shift their attention from inflation to corporate profits.

One number that stands out is the Producer Price Index. Producer prices are now increasing about two percentage points faster than consumer prices, the widest gap we've seen in more than four years.

That suggests many companies are absorbing higher costs instead of passing them on to consumers. That's helpful for keeping inflation in check, but it can also squeeze profit margins.

So far, companies are holding up well. Only about 10% of the S&P 500 has reported earnings, but nearly 90% have beaten expectations. Expectations remain high, with analysts forecasting roughly 25% earnings growth compared to the same quarter last year.

What We're Watching

This week should be relatively quiet from an economic standpoint.

The Federal Reserve is in its blackout period before the July 29 meeting, so we won't hear from policymakers until after the meeting concludes.

Instead, investors will be focused on earnings, particularly from large technology companies like Alphabet and Intel. Those reports should provide a better sense of whether the AI investment story continues to support corporate growth.

We'll also continue watching developments in the Middle East and any impact they may have on energy prices.

Bottom Line

The market still has plenty to work through. Inflation remains above target, companies are managing higher costs, and geopolitical risks continue to create uncertainty. At the same time, earnings season has gotten off to a solid start, and the economy continues to show resilience.

For long-term investors, the bigger picture hasn't changed. Markets will continue to react to economic data and global events, creating periods of volatility along the way. That's a normal part of investing. Staying disciplined and focused on your long-term financial goals remains far more important than reacting to every headline.

If you have questions about your portfolio or financial plan, don't hesitate to reach out. We're always happy to help.

Often quoted in major national media, Adam is a Chartered Financial Analyst (CFA^®), a CERTIFIED FINANCIAL PLANNER™ (CFP^®), and has been included on the Forbes NextGen Best-in-State Wealth Advisors 2019 list. He is a member of the CFA Society of Los Angeles and the CFA Institute. Adam helps establish asset allocation strategy as a member of the EP Wealth Investment Committee, which supports all EP Wealth Advisors and their clients. The Committee’s top-down approach to portfolio construction begins with an outlook on the economy’s likely direction, followed by the implications for different economic sectors and asset classes. This culminates in strategic selection of the individual stocks, bonds, mutual funds or other investments deemed most appropriate for each individual client’s portfolio. 

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