What happened
A broad cross-section of stocks were in rally mode on Wednesday. Market watchers were focused on the Federal Reserve's ongoing battle to control rampant inflation. The latest U.S. government data showed that inflation cooled more than expected last month, which could convince the Federal Reserve to slow the pace of interest rate hikes. Interest rate increases are what the Fed uses to control rising prices.
With that as a backdrop, shares of Zscaler (ZS -0.78%) rose 6.4%, Datadog (DDOG -2.68%) jumped 5.4%, and Wix (WIX -0.88%) was up 2.9% as of 11:14 a.m. ET.
There was only one piece of company-specific news helping fuel the rally, which suggests most investors were squarely focused on the improving economic outlook.
Image source: Getty Images.
So what
The U.S. Bureau of Labor Statistics released its monthly inflation data for April and it was welcome news for consumers and investors alike. The Consumer Price Index (CPI), the most widely followed measure of inflation, rose 4.9% in April compared to the prior year, while edging just 0.4% higher sequentially. This marked its lowest rate in two years.
While inflation remains high by historical standards, it continued to improve, down from March's rate of 5%, while also notching its lowest rate since April 2021. This was better than economists' forecasts of 5%. The "core" data, which excludes volatile food and energy prices, climbed 5.5% year over year and 0.4% month over month, both of which were in line with economists' expectations.
The underlying data revealed, however, that challenges remain. This biggest contributor to the overall increase was food, which rose 7.7% year over year, more than offsetting an easing of the energy index, which declined 5.1%. On a more positive note, gas prices were down 12% year over year.
Just last week, the central bank boosted the federal overnight lending rate to a range of 5% to 5.25%, an increase of 0.25 basis points. This marked the Fed's ninth successive rate hike, bringing the benchmark lending rates to their highest point in almost 16 years.
The Fed is trying desperately to rein in growing inflation and interest rates are its primary tool to accomplish this monumental task. When the cost to borrow money increases, consumers and businesses are encouraged to cut back on spending. This, in turn, slows demand -- which any student of economics will tell you -- and causes prices to fall.
While inflation continues to slow compared to the four-decade high it hit in mid-2022, the Fed has to walk a fine line. If the Fed doesn't raise rates fast enough, the economy will continue to suffer from historically high prices, but if it increases interest rates too quickly, it risks pushing the economy into recession.
Now what
There was some company-specific news that helped boost one of our trio of stocks. Datadog announced a new integration with artificial intelligence (AI) chatbot ChatGPT. The monitoring and security platform optimizes performance while keeping track of usage patterns and costs, helping businesses avoid unexpected bills. AI has been seeing broad adoption and this move will open up a new revenue stream for Datadog and potentially attract additional customers.
On a more general note, improving macroeconomic conditions could provide a boost for these three companies:
- As inflation continues to abate, businesses will be more likely to increase spending, which bodes well for Zscaler's cybersecurity and Datadog's web monitoring and cloud security services.
- This also holds true for Wix, a provider of digital sales tools to businesses.
It's worth noting that while these stocks are cheaper than they've been in years, they still fetch a premium. Shares of Datadog, Zscaler, and Wix are currently selling for 10, 8, and 3 times next year's sales, respectively, when a reasonable price-to-sales ratio is between 1 and 2. However, investors tend to place a premium valuation on companies with a history of strong growth and large market opportunities.
For investors willing to stomach ongoing volatility in exchange for the potential of robust gains three to five years down the road, it's worth considering adding these stocks while they're on sale.
