This week’s decline in two key inflation indicators has given investors an excuse to buy stocks. At this point, we have retraced 50% of the losses to the start of the year. The idea behind how this recent upward move has happened is that inflation is down and the Federal Reserve no longer needs to maintain its ultra-tight monetary policy. Is it a good bet?
That’s not the case, according to several Fed officials who were asked by the US central bank this week to address the markets almost daily. Even the more conciliatory members continued to point out that nothing has changed in their thinking. For one person, every member of the Federal Reserve pointed out that the market should expect another interest rate hike at their September 2022 FOMC meeting. Additionally, the Fed’s balance sheet reduction will continue. tirelessly.
Clearly, investors do not believe these warnings. The bulls are convinced that inflation will continue to fall to the point that the Fed will change its mind. As such, this belief is enough to support, if not justify, further purchases. It’s certainly an attractive story given the data.
Everyone should have been happy with the inflation data. It indicates a spike in inflation. The Consumer Price Index (CPI) and Producer Price Index (PPI) came in below expectations. However, the CPI increase of 8.5% and the PPI gain of 9.8% are still very far from the Fed’s official inflation target of 2%. Even if we had zero additional inflation for the rest of the year, we wouldn’t hit the Fed’s target.
Some optimistic investors might also bet that since we won’t know what the Fed is going to do until September, markets may continue to swing for at least a week or two. As things stand, bond watchers have already lowered their expectations for the magnitude of the Fed’s rate hike by 75 to 50 basis points at this meeting.
Most of the decline in the CPI and PPI can be attributed to lower energy prices. Nationally, we see gasoline prices below $4 a gallon, while oil has recently fallen below $90 a barrel.
But here’s the catch.
The Fed has little influence on the future price of oil. Geopolitical events, currencies, and global supply and demand are much more important factors in determining where the price of oil goes next. What if oil climbs above $100 a barrel next week? What effect will this have on the future CPI report, and how will the markets react?
As I’ve been advising readers for weeks, my target for the S&P 500 on this rally was 4,100 to 4,200, give or take a few points. This week we hit 4,257. Now what?
I warned readers in June that after this relief rally, “somewhere in mid to late August”, we would initiate a decline that could take us back to 3,800 to retest or slightly break the lows of the year. This remains my forecast.
However, this decline will be accomplished in fits and starts. Investors are caught in the throes of greed and FOMO. So, for example, next week we might see a series of shallow pullbacks, only for those who missed that rally to buy the dip. Those Johnny-come-latelies will be expecting even higher heights. They might even push us back towards 4,250 on the S&P 500. However, by the end of next week, we should be down.
This type of action in the markets could continue over the next few weeks. As it is, I would expect the markets to make lower lows and lower highs. By September 2022, we will likely see the lows I predict. What is my thought behind this rather bleak prediction?
I expect oil prices to have bottomed out for now and will rise over the next few weeks. Geopolitical tensions could also escalate, adding strain to global markets. The Fed will continue to tighten, despite the mood of hope infecting investors right now. Corporate earnings will continue to fall and earnings warnings will become more common as the economy continues to slow.
None of my thoughts are original. I’m just echoing the case of the bear. The only difference is that I’ve been predicting it since December 2021.
Bill Schmick is registered as an investment adviser representing Onota Partners Inc. in the Berkshires. He can be reached at 413-347-2401 or by email at [email protected] Opinions expressed by columnists do not necessarily reflect the views of The Berkshire Eagle.