What now for the markets after the positive inflation report?

There’s a big question on the minds of stock market investors these days: have we emerged from the jaws of the bear market?

We asked three strategists if the stock market has seen its lows. Their answer: yes. This does not mean that the worst is behind us from an economic point of view.

And the market will likely remain volatile until there is more evidence that inflation is falling, consumer confidence is improving and the economy is showing steady growth. But the worst is probably behind us in the stock markets.

The stock market has come alive since hitting a low this year on June 16. The Morningstar U.S. Market Index has rebounded nearly 16% since mid-June and is now down 11.85% for the year. The Nasdaq Composite is up 20% from its mid-June lows, putting it in a new bull market by some popular definitions. The tech-hevy index is now down 18.31% for the year.

Animal spirits are running high as the Federal Reserve Board’s measures to tame inflation gain traction. Companies reported better-than-expected results in the second quarter given the difficult environment. The Federal Reserve Bank of Atlanta’s economic growth tracker GDPNow expects 2.5% growth in the third quarter, after two consecutive quarters of economic contraction.

Back-to-back inflation reports on Wednesday and Thursday showed prices fell in July from June, triggering a wave of euphoria among investors and pushing benchmarks to their highest levels since the spring.

“June probably represents the bottom of the stock market,” says Jack Manley, global market strategist at JP Morgan Asset Management, with $2.5 trillion under management. “But it won’t be a direct return and we expect more volatility. Who would have ever thought that an 8.5% reading on the CPI would be a famous metric? »

Manley says “we’re not out of the woods yet” and he’s watching some key data points that will support a more stable upward trajectory in the market. Top of his list includes:

  • Weekly jobless claims and job offers: Job postings plunged in June to their lowest levels since September 2021, signaling a slowdown in what has been an extremely tight labor market. The softness is welcome as it will ease pressures on wage growth that have been at multi-decade highs. “We won’t see anything positive anytime soon,” Manley says. “If the numbers continue to deteriorate, the Fed will likely slow the pace of its interest rate hikes and that would be a net positive for the markets.”
  • Purchasing Manager’s Index surveys: As forward-looking indicators, PMI surveys for manufacturing and services provide early clues about the health of the economy. The July U.S. manufacturing PMI of 52.2, although the weakest in two years, remained in growth territory and showed the weakest rise in the price of goods in a year and a half. July’s US Services PMI showed contracting growth to 47.3. “I would like to see the PMI at 50 or north of 50,” Manley says, to be sure that trading conditions would support stock market growth.
  • Consumer sentiment: Current levels are abysmal and at their worst in 50 years. “Retail therapy is a reality in this country,” Manley says. If consumers are reluctant to spend, it will undermine the economy and the markets. “I would like to see the consumer confidence numbers go up.”

There’s no doubt markets bottomed out in June, says Morningstar’s chief U.S. market strategist David Sekera, though he expects volatility to continue as investors continue to have overreactions to data points. “The economy is booming and jobs are being filled at a healthy pace,” he says. “We were in rare territory in the way undervalued markets had become.”

The four headwinds identified by Sekera as having the most negative impact on the stock market have begun to dissipate. Those headwinds are now turning into “tailwinds,” he says, and include:

  • Economic growth: After two negative quarters of gross domestic product growth, the economy is now expected to grow at a 2.5% rate in the third quarter. This matches Morningstar’s forecast for average annual GDP growth of 3% in the second half.
  • Fed tightening: With at least one and likely two interest rate hikes to come by the end of the year, this will likely mark the end of any further hikes, outside of the Fed’s program to unwind its balance sheet, Sekera says.
  • Inflation: June’s consumer price index marked the highest for the year, Sekera argues.
  • Bond yields: The 10-year Treasury started the year around 1.5% and is now around 2.9%. While long-term yields could drift higher in the coming months as assets on the Fed’s balance sheet are depleted, “the preponderance of rate hikes is already behind us,” Sekera says.

After buying trillions of securities to support the economy during the pandemic, the Fed is now shrinking the amount of assets on its balance sheet, a process called “quantitative tightening.”

Scott Clemons, chief investment strategist for Brown Brothers Harriman’s private banking division, with $60 billion under management, says he’s “increasingly confident we’ve seen the bottom.” What created strong downward pressure on markets earlier in the year was anxiety that the Fed was too late in tackling inflation and, once the central bank started, however slow.

“It looks like the fever surrounding the Fed’s moves has started to die down,” Clemons says.

The data he is watching closely for further confirmation that the stock market’s upside reversal will last include:

  • Inflation: The consumer price index and producer price index have both shown significant improvement recently and he expects further improvement as commodity prices, especially gasoline, continue. down.
  • Fed tightening: The Fed is nearing the end of its tightening cycle, with the futures market pricing in rates of 3.00% to 3.25% by the end of the year. “This could be the relief the market so desperately needs,” Clemons said. He notes that there was a 120% rise in stocks from March 2020 to January 2022 without any measurable pullback, which makes this year’s 20% drop seem like “the most normal thing that has happened.” over the past two years”.
  • Consumer confidence: The current lows, below what was seen at the start of the pandemic, are worrying him, and sentiment will need to recover before we see lasting gains in the stock market.
  • Works: “It’s hard to imagine a recession if we continue to create hundreds of thousands of jobs,” says Clemons. The July jobs report, in which more than half a million jobs were added and which suggested the Fed should maintain an aggressive tightening stance, was likely an outlier. Adding 100,000 to 200,000 jobs would be manageable and healthy.

“If inflation slows and we ease consumer confidence, that could trigger a powerful recovery,” Clemons says.