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4 Important Market Topics to Determine Where We Go from Here


Last week, I talked about the likelihood of the S&P 500 (SPY) remaining range-bound due to the mix of bullish and bearish forces. One of the bullish forces was the resilience in earnings which have remained positive (+6% in Q2) despite adverse conditions. Another was the signs showing that inflation may have peaked, and there was hope that August would continue a trend of moderating inflation on a monthly basis which would be a leading indicator of a Fed pivot (more specifically, a deceleration in the pace of hikes). Of course, the inflation outlook is much more different following the CPI report on Tuesday. In today’s commentary, I want to focus on why this development is so important. Then, I want to discuss its impact on our strategy. After, we will dig into a review of some market topics. Read on below to find out more….



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(Please enjoy this updated version of my weekly commentary published September 16th, 2022 from the POWR Stocks Under $10 newsletter).

Over the last week, the S&P 500 (SPY) is down by 2.5%, although we are down by more than 5% from Monday’s close.

Monday seems like a long time ago given that the S&P 500 was above 4,100 and looked set to keep rising if the inflation number came in soft. There were also reasons to expect inflation to continue the trend from July showing a weaker number.

This was due to lower commodity prices and weakness in terms of leading indicators for inflation.

Some areas did show lower prices like gasoline and vehicles, but other areas continued to show rising prices like services and rents. And, these are notably the areas that correlate with ‘sticky’ inflation which is exactly what the Fed wants to avoid.

The hot inflation print was enough to wipe out all of the gains from the past week. Sometimes, the market can overreact, but I don’t think this is one of those times given that falling inflation is essential to any bull case as it brings with it relief on the rate front and a boost to margins.

On the other hand, inflation plateauing at these high levels means that the Fed is going to stay hawkish and pursue a restrictive level of monetary policy for longer.

In fact, the debate has shifted for the next FOMC meeting. Prior to the CPI report, the debate was about 50 basis points or 75 basis points. Now, it’s between 75 and 100 basis points.

Last week, I felt that the bullish and bearish forces were at equilibrium. This shifts the dynamic in the bears’ favor as it reduces the strength of the bullish tailwind of falling inflation and leads to a more hawkish Fed for longer.

If we parse the Fed’s words, then it could be said that 2 months of lower monthly inflation could lead to the Fed slowing down its hiking. The 0.6% monthly core CPI gain resets the clock.

The overall economy and earnings picture has been remarkably resilient. Earnings grew 6% in Q2 and are expected to grow about 5% in Q3. But, these figures were not calculated with the assumption of higher rates for longer.

Just one more note on this. These rate hikes end in 2 ways – either inflation breaks before the economy does or inflation breaks and the economy breaks.

The former scenario can’t be discounted as it’s exactly what’s happened this year, but I think the odds of the latter scenario have sharply risen.

Strategy

If we had gotten a ‘good’ inflation print, I think we could be re-testing the August highs of 4,300. A bad reading and our next major test will be the recent mid-June low at 3,600.

Given this, we are once again, shifting to a more defensive strategy and will be looking to use pockets of strength to reduce exposure.

On the long side, we will continue to identify fundamentally strong stocks for long-term ownership and short-term, low-risk setups. But, the larger focus will be on preserving our firepower when more offensive tactics will be rewarded.

Market Topics

Now let’s do a review of some important market topics…

Energy: We are seeing continued weakness in oil and energy prices. However, there are some attenuating circumstances.

For one, the US is a seller of oil as it is selling off a portion of its strategic petroleum reserve (SPR), and China’s economy continues to operate at full capacity, which is hurting oil demand.

So, this is a positive, but it’s fair to acknowledge that some unusual circumstances are involved.

Gold and Silver: Precious metals kind of had a lose-lose situation entering the CPI report. A soft number probably means a ‘risk-on’ stock market (SPY) and investors are looking to buy tech, not precious metals.

A hot number means a tighter Fed, bigger rate hikes, and higher for longer.

All of these paths are bearish for precious metals. I can’t see a sufficient reason to rally, outside of an unforeseen crisis or a pivot in the Fed’s policy.

HOPE model: One model used to describe how tighter monetary policy circulates through the economy is HOPE. H is for Housing, O is for New Orders, P is for Profits, and E is for Employment.

We are somewhere now between the O and P as New Orders are now in expansion mode, while earnings have not yet shown signs of damage, in the aggregate.

Bullish Catalysts: We’ve had 2 fizzle out. One is that some of the short-term extremes in sentiment and positioning have resolved, i.e., the rubber band is no longer stretched. Shorts and put-holders were wiped out during this rally.

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All the Best!

Jaimini Desai
Chief Growth Strategist, StockNews
Editor, POWR Stocks Under $10 Newsletter


SPY shares closed at $385.56 on Friday, down $-4.56 (-1.17%). Year-to-date, SPY has declined -18.22%, versus a % rise in the benchmark S&P 500 index during the same period.


About the Author: Jaimini Desai

Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of the POWR Growth and POWR Stocks Under $10 newsletters. Learn more about Jaimini’s background, along with links to his most recent articles.

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