Implied Progress on Inflation Boosting Investor Hopes
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I can’t think of any time in recent history when market bulls and bears were so vociferous in their positions. With rumors abounding that this week’s inflation data will be decidedly tame, traders and investors stepped in, seeking to seize on a very oversold market to capture some gains and scalp trades where possible. To date, the market has been well-defined as one step forward, two steps back.
The summer rally that turned out to be a quintessential bull trap has rattled investor sentiment bigtime. It was like pouring salt into a wounded market under the premature notion that the Fed would somehow pivot from their hawkish narrative. To be sure, Jay Powell has stated more than once that the Fed will not make the same mistakes of the past of letting inflation fester, leading to an extended period of stagflation.
Even if this week’s Consumer Price Index (CPI) and Producer Price Index (PPI) headline data do come in under forecasts, the Fed will hold to their plan to raise the Fed Funds Rate by 75 basis points regardless of the read of inflation, as they will remain on script. From there, I don’t think anyone knows what to expect because oil, gas and agricultural prices could move higher following a brief respite from a massive move where the Commodity Research Bureau (CRB) index has doubled in 15 months.
Wages and rents will remain at current or higher levels, durable goods prices might tick lower, but the dollar will likely remain very firm, thereby entering the conversation of pressuring Q3 earnings. The dollar has rallied 23% year-to-date. There is no way that profit margins from U.S. multinational companies won’t be impacted by this torrid rally in the greenback as it soars to multi-decade highs.
The risks outside the U.S. are substantial, and thankfully our economy makes up about 25% of global gross domestic product (GDP). America is the world’s economic draft horse, and barring any further bungling by the Biden administration and Congress to stifle growth in the energy sector, the domestic economy has a very good chance of doing a “touch-and-go” soft landing. This assumes the Fed doesn’t overshoot on hawkish policy directives. Again, this whole Fed thing is a highly fluid situation where the market is hanging on every speech and interview — most of which is very reactionary, lacking confidence and showing impatience about letting then current rate hikes work through the system.
Last month’s challenges for the market are the same for this month as well. Fed monetary policy is hawkish, the war in Ukraine staggers on, the energy crisis in Europe is taking that region into recession, COVID-19 lockdowns in China are prevalent, the dollar is trading at 22-year highs and interest rates are steadily rising. These factors have created a very uncertain investing landscape where opinions are greatly divided between those that claim these headwinds are priced in versus those that state that market conditions will worsen.
The reality is that there remains widespread uncertainty about the extent of a domestic and global economic slowdown, along with black-swan risks that could be highly disruptive to the stock market. The American Association of Individual Investors (AAII) hasn’t been this bearish in years — a good thing in that it has been an accurate contrarian indicator. Professional asset managers are holding historically high levels of cash for good reason; they just don’t know what lies ahead.
As much as we would all like some of these dark clouds to lift and reveal some blue sky with which to be more aggressive investors, the prudent path ahead for the near-term is one defined by capital preservation, the hedging of downside risk and being vigilant to either get more defensive or pounce when the coast become clear, inflation is clearly on the decline and some of the macro/geopolitical risks stabilize. To put it simply, the market is in need of some “white swan” events.
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