Inflation Persists, But So Do Stock Opportunities: Rally On

Key Points

• The January CPI report was hot and will keep the FOMC from cutting rates, but it isn't the end of the stock market rally.
• Earnings growth, cash flow, and capital returns underpin the bull market and are not expected to cease in 2025 but grow. 
• Analysts continue to lift their S&P 500 targets and see it advancing at least 10% by year's end. 

The January CPI report was hot, much hotter than expected, and raised the risk of FOMC tightness. Not just higher-for-longer near current levels but a reduced chance for even a single 25 basis rate cut in 2025 and a growing possibility hike will be back on the table. This increases the odds of a Fed-induced recession, but opportunities for investors persist. Inflation is a hot problem but, so far, has yet to impact economic activity or the uptrend in stocks. 

Economic activity remains solid, with Q1 GDP forecast to run near 3.0% in Q1. What this means for investors is continued stock market growth and a high likelihood that the uptrend in the S&P 500 NYSEARCA: SPY will continue. The market pulled back following the CPI release and may deepen the move before the rebound begins, but a rebound is the most likely outcome; the CPI-induced dip is a buying opportunity. 

Labor Market Health, Earnings Growth, and Capital Returns Support S&P 500 Uptrend

Labor market strength is one reason the CPI report is less of a selling event than some would think. The January labor data included significant annual revisions but aligned with the trends. The trends include steady job creation, employment growth accelerating at year’s end, low unemployment, and rising wages. Wages grew at a 4%+ pace, a critical factor for inflation and the consumer outlook, underpinning inflation yet sustaining consumer health. According to the CPI, inflation is up 3.0% and 3.3% at the headline and core levels, leaving the “average consumer” stronger than a year ago despite the higher prices. 

S&P 500 earnings growth is also a factor in why the index can rally higher. The decreased chances for lower rates will impact the outlook, but growth is expected, nonetheless. As it is, the consensus figures assume steady growth in Q12025 relative to 2024 and sequential acceleration throughout the year. The difference is that all sectors will produce growth, compared to only nine in 2024, with six growing by more than 10% and leaders including technology, healthcare, and industrials. In 2026, those trends are expected to continue and produce another year of mid-teens earnings growth. 

Earnings are critical on their own but more so because of the impact on capital returns. The S&P 500 companies will increase dividends and buybacks on average by high-single and low-double-digit amounts in 2025 and sustain the trend in 2026. That means a dwindling share count compounded by business growth, dividend distribution, and balance sheet improvements, which are a strong tailwind for shareholder value. 

The Risk is Inflation; It is Accelerating

The risk is inflation. The January data is hot and shows acceleration contrary to the expected contraction. Inflation can continue to accelerate in this scenario because the Fed’s policy may be too lenient, and Trump’s policies are expected to be inflationary. On the one hand, tariffs may impact prices, while on the other, easing business headwinds are expected to drive expansion and labor investment.

The market reacted to the news as expected, with the S&P 500 declining immediately after the release. However, traders seized the early morning sell-off as an opportunity, showing their support at the 30-day EMA. If this level continues to be supported, the market could quickly rebound and move up to set new highs. If not, the S&P 500 could move to the 5,960 to 5,790 level, where support is firmer. In that scenario, the market could remain range-bound until later in the year.