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The market had a field day this week with its 4th straight green week on the back of signs of disinflation in the Consumer Price Index (CPI), Producer Price Index (PPI), and Import-Export Price Index reports for July. All this data supports the peak inflation narrative.
All 11 S&P 500 sectors closed higher for the week. Gains ranged from 1.2% (consumer staples) to 7.1% (energy). Cyclical sectors saw some of the biggest gains and value stocks outlegged growth stocks in a move that showed reduced fears about the economy suffering a hard landing. The Russell 3000 Value Index increased 3.9% versus a 3.0% gain for the Russell 3000 Growth Index.
The S&P 500 crossed an important level (4,231) that some will interpret as a telltale signal that the low in June was the low for the bear market. The week’s gains were secured almost entirely from trading on Wednesday and Friday. Prior to Wednesday, which is when the CPI report was released, the major indices were all down for the week. The slow start was from reservations about the market being due for a pullback after the big run off the mid-June lows, some revenue warnings from NVIDIA ($NVDA) and Micron ($MU), and some uncertainty in front of the CPI report.
The CPI reading proved to be a major turning point for sentiment. Total CPI was unchanged month-over-month and core CPI, which excludes food and energy, was up a smaller-than-expected 0.3%. The key stat here was that the annual pace of total CPI moderated to 8.5% from 9.1% while the annual pace of core CPI held steady at 5.9%, meaning it did not move higher as had been feared.
The fact that inflation hadn’t gotten worse trigged the rally in the major indices, as investors relished the idea that inflation might have peaked, that the Fed might be able to temper the pace of its rate hikes, and that the U.S. economy, which learned last week that 528,000 positions had been added to nonfarm payrolls in July, might be able to enjoy a soft landing.
Various Fed officials attempted to downplay the idea of the Fed being ready to take its foot off the rate-hike pedal, not to mention pivoting in 2023 to a rate-cut cycle, yet equity market participants seemed to disregard the sentiment.
The view in the stock market was that inflation rates will continue to moderate in coming months and that Fed officials will ultimately be convinced to soften their hawkish-minded tone as a result. Then the PPI data and Import-Export price data move in the same direction as the CPI data, further solidifying that view.
Stocks wavered a bit in the wake of the PPI report on Thursday, but by Friday morning, that move had been written off as just a case of taking some money off the table after a big move. By Friday, buyers were back in action.
The S&P 500, which was flirting with 3,600 in mid-June, settled Friday at 4,280. The close above 4,231 will be seen by some as an important technical and psychological development. That level marked a 50% retracement of the losses suffered between the January 3 closing level (4,796.56) and the June 16 closing level (3,666.77). This is important because there has not been a bear market rally that pushed past the 50% retracement and then fall further to make new lows since 1950.
That doesn’t mean we’re in the clear, but it does resonate for some as a beacon of identifiable downside risk and a reassuring historical precedent.
There was also a revival this week of speculative activity that translated into huge percentage gains for many of the so-called meme stocks, as well as the SPAC and profitless story stocks that were all the rage last year. Their moves were clear reflections of a risk-on mindset driven by the hope that the Fed won’t have to go as far as it thinks into restrictive rate-hike territory.
The Treasury market wasn’t as optimistic. The 2-yr note yield, which is sensitive to changes in the fed funds rate, ended the week up two basis points at 3.25%, virtually unchanged from where it was when the CPI report was released on Wednesday. The 10-yr note yield settled the week up one basis point at 2.84%, up about five basis points from where it was trading before the release of the CPI report.
Obviously, stable inflation is better than rising inflation, but it is still ridiculously high. The Fed’s inflation target is 2.0%, whereas CPI is up 8.5% year-over-year and PPI is up 9.8% year-over-year. There is a lot more room for inflation improvement and there needs to be a lot more improvement to convince the Federal Reserve that inflation is back under control.
That will be an ongoing war, but there was no doubt that the stock market won the mental battle this week in seeing what it wanted to see, which was a lower inflation rate in July than it saw in June.
Next week we only have retail numbers and FOMC minutes to look forward to. Canada will report their CPI and both New Zealand and China will report on their interest rate decision. Overall, next week does not have a very impactful lineup. I believe next week we will see the market move sideways at the least. If not, the indexes will be looking to continue upwards with a fifth green week in the market.
My bullishness on the last week was correct as data and sentiment continue to trend in the right direction for the short term. And with no heavy hitting data releases coming, I think there is a good chance that continues next week. However, over the long term, I am still bearish as I believe the Feds rate hikes take a good amount of time before their effects are felt, let alone reported in data.
Maybe I’ve just been spoiled by buying so many cheap dividend stocks in this market that I want things to stay bearish! Regardless of the way things move, we will buy structurally sound companies that pay safe dividends and have a promising future. We did this last week with some movements in the portfolio towards the Global X S&P 500 Covered Call and Growth ETF ($XYLG). Read the portfolio update here.