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WHAT. A. WEEK. There was turmoil and losses in the cryptocurrency market as FTX was hit by a crypto-bank run. The week ended with FTX Group filing for Chapter 11 bankruptcy. And that’s just the intro for this week.
Midterm elections were held on Tuesday, the final results of which are mostly unknown as of this writing. Reports suggests the GOP will manage to win a narrow majority in the House, yet some Senate races are still too close to call. In fact, it might take the December 6 runoff election in Georgia to determine if Democrats or Republicans have control of the Senate.
With the GOP holding a thin majority in the House, it is likely that the next few years likely won’t include any new major legislation. In other words, there will be political gridlock for the next few years unless the two parties work together to avoid becoming a “do nothing Congress.”
The stock market this week was anything but a “do nothing market.” It was filled with trading excitement that produced the best day for the market on Thursday since 2020 and some huge gains for the major indices.
The main catalyst for the excitement was the October CPI report, which came in better than expected.
Briefly, total CPI increased 0.4% month-over-month in October (consensus 0.7%) while core-CPI, which excludes food and energy, increased 0.3% month-over-month (0.5%). The monthly changes left total CPI up 7.7% year-over-year, versus 8.2% in September, and core CPI up 6.3% year-over-year, versus 6.6% in September.
The market had a couple takeaways from this report (a few of which I do not agree with). First, the report helped validate the peak inflation view. Second, the report may also compel the Fed to take a less aggressive rate-hike approach at the December FOMC meeting. And lastly, some encouragement came from the understanding that the shelter index (computed with a lag) contributed more than half of the monthly all items increase, suggesting price increases moderated in many other areas.
This was welcome inflation news. When combined with a huge drop in the dollar and market rates, we saw a huge rally on Thursday. The Nasdaq Composite for its part soared 7.4%. Many of the beaten-up growth stocks made double-digit percentage moves, including Amazon.com ($AMZN), but just about every stock came along for the CPI ride.
Growth stocks were the favored rebounders as the 10-yr note yield dove 31 basis points to 3.84%. The 2-yr note yield, which is sensitive to changes in the fed funds rate, plunged 32 basis points to 4.31%.
Those moves were precipitated by changing rate-hike expectations. The fed funds futures market now sees an 83.0% probability of a 50-basis points rate hike at the December FOMC meeting (versus 56.8% before the CPI data) and a terminal rate of 4.75-5.00% by June (versus 5.00-5.25% before the CPI data).
The dollar got clobbered on those same shifting expectations. The U.S. Dollar Index fell a whopping 4.0% on the week to 106.42.
The drop in the dollar took some of the pressure off the multinationals and aided in the belief that downward revisions to 2023 earnings estimates may not be as severe as feared, assuming the weakness persists.
Another factor aiding that belief was a Bloomberg report that China relaxed quarantine guidelines for inbound travelers and is aiming to avoid city-wide testing when COVID transmission chains are clear. This news, which came on Friday, helped boost oil and copper prices.
It also added to the market’s newfound enthusiasm for a year-end rally. The S&P 500, which dipped below 3,500 following the disappointing September CPI report in mid-October, peeked its head above 4,000 on Friday and closed just below that level when the final bell for the week rang.
All 11 S&P 500 sectors ended higher this week, none bigger than the information technology sector (+10.0%), which was driven by a huge comeback effort among the semiconductor stocks and by Apple ($AAPL) and Microsoft ($MSFT). For the week, the Philadelphia Semiconductor Index was up 14.9%.
Other standouts included the communication services (+9.2%), materials (+7.7%), real estate (+7.1%), consumer discretionary (+5.9%), and financial (+5.7%) sectors. The weakest performers were the defensive-oriented health care (+1.8%) and utilities (+1.4%) sectors.
Dividend Dollars’ Opinion
That’s it for the recap. Now for my take! I obviously trimmed some gains early with my cuts last week. This week would have been ideal, but there’s no way of knowing that the market was going to moon after that CPI report. I personally think the rally on Thursday and Friday was unfounded, for a couple of reasons.
The first reason is that many people are misunderstanding what the CPI really is really telling us. Annual inflation year-over-year through last October was 7.7%, which is lower than the last year-over-year reading for August. On the surface this looks promising, but you have to look at the bigger picture. We don’t care what happened 11-months ago with inflation. We care about what happened last month and last month was not good.
Look at the picture below. The blue line is the annual CPI inflation rate. The purple line is the actual CPI index value. The purple line is key here. Inflation is still rising, and quickly. The market rallied off of the headlines of the blue line that showed a decline in the annual rate from 8.2% to 7.7%. This is not an actual decline in inflation, it’s a slow down in the annual rate which is in fact still increasing! The only reason we are seeing the CPIYOY rate start to decrease is because our numerator in the percent change formula ((new value-initial value)/initial value) has caught up significantly because we have been in a high inflation environment for more than 12 months.
The second reason is that the market’s idea that the Fed may start to pivot is total crazy-talk. Inflation has not peaked and the Fed will not stop raising rates until it does. And when it does, I image we will stay at that rate for some time before we see a decrease. A pivot is a long ways away for us. Dallas Fed President on the Thursday said that he doesn’t see “the decision about slowing the pace as being particularly closely related to the incoming data.”
The market totally misread the CPI release, in my opinion, and the rally we saw as a result is unfounded. But oh well, my mistake was assuming that markets would be logical! They rarely are. Market movements are more based on expectations. And expectations of expectations. This is the danger inherent in trying to time the market and understand the macros. You may get it, but the market may not even care. Inflation is the highest we’ve seen in 40 years! But this newest reading showed that it is increasing a pace slower than we expected! Imagine the worst and you’ll never be disappointed I guess!
In summary, I trimmed my positions too soon. Oh well, gains are gains! In case you couldn’t tell from my opinion piece, I am still bearish. We still don’t have a great picture on the progress of inflation. I called a downtrend through the end of the year too soon, but I do think that it will come.
Because of this opinion, I sold some positions, took some gains, and grew my cash position to about 8% of my whole portfolio and opened a short position on the market. I’ll be looking to deploy my cash closer to the end of the year and will watch my short closely. You can read about these moves in my weekly portfolio update here.