Commodities are down … inflation is likely to be down … hopes the Fed will slow their hiking campaign … the S&P is on the verge of a first for 2022

Brace yourself.

You might not be expecting this, but…

Good news is coming.

The last several weeks have seen dramatically lower prices for all sorts of commodities – oil, natural gas, copper, aluminum, and steel, just to name a few.

As we’ll discuss today with the help of our technical experts John Jagerson and Wade Hansen, these lower prices are likely to result in a domino effect, leading to a market rebound as we look toward the upcoming holiday season.

Today, let’s look into why John and Wade believe good news is on the horizon.

***The positive ripple effects of cooling inflation are coming

If you’re new to the Digest, John and Wade helm our newsletter Strategic Trader. This premier trading service combines options, technical and fundamental analysis, and market history to profit from the markets, whether they’re headed up, down, or sideways.

Let’s jump into John and Wade’s Wednesday update as they analyze what’s been happening with commodities:

This past month has seen a major shift in the commodity prices that impact headline inflation numbers.

After topping out just under $125 per barrel on Jun. 14, the price of oil has plunged lower – closing under $100 per barrel on Tuesday, the first time since May 10…

Agricultural commodity prices are also dropping.

We’ve been watching wheat futures for the past few months because the price of wheat has been directly impacted by the war in Ukraine.

In March, the price of one wheat futures contract (which controls 5,000 bushels of wheat) skyrocketed to a high of $1,363.40. During the next few months, the price of wheat remained high and volatile.

That all changed on Jun. 21 when the price of wheat broke lower. One wheat futures contract is now trading just above $800.

So, we’re seeing both energy and food prices coming down dramatically.

It just so happens that energy and food make up roughly 23% of the total Consumer Price Index weighting. So, as the prices of these categories drop, it will ease the overall CPI reading.

But let’s add one more piece of good news.

The single largest component of the CPI is housing costs, accounting for more than 30% of the weighting.

As we’ve reported here in the Digest, housing costs – whether we’re talking mortgage costs or rental rates – have soared here in 2022. But we’re finally seeing some cooling here as well.

From Bloomberg on Wednesday:

After surging 11.4% over the past 12 months, the median national rent for a one-bedroom apartment rose just 0.5% in June compared to a month earlier, while the median two-bedroom rent fell 2.9%, according to data from rental marketplace Zumper. 

The decline in prices for two-bedrooms is the “most significant drop we’ve seen since pre-pandemic times,” according to Crystal Chen, a spokeswoman for Zumper.

“Renters are sending a clear message to property owners that they’re not able to pay sky-high rents, and they anticipate a recession.”

And news this morning is that mortgage rates continue to pull back. Your standard 30-year fixed rate is back down to 5.3%, after having topped 6% in recent weeks.

Together, housing, energy, and food costs account for over half of the CPI…and their prices are finally easing. This should result in lower official inflation numbers.

Back to John and Wade on the impact of such an outcome:

This is good news for Wall Street because if inflationary pressures start to drop, the Federal Reserve won’t have to raise interest rates as high – which means growth in the U.S. economy likely won’t contract as much.

***Traders are now moderating their bets on expectations for Fed rate hikes

To get a sense of where professional traders think the Fed will take rates, we can use the CME FedWatch Tool. This shows us the probabilities of a Fed rate hike, or cut, that traders are pricing into Fed Funds futures contracts.

Here’s John and Wade’s analysis as of Wednesday:

…Interest-rate hike expectations [are] moderating in the CME FedWatch Tool.

As you can see below, one week ago, traders were pricing in a 13.2% chance that the Fed would be raising the Federal Funds rate to 4% by its July 2023 monetary policy meeting.

At that same time, they were only pricing in a 6.3% chance the Fed would be cutting the Federal Funds rate back down to 3% (assuming the Fed raises rates above 3% by the end of 2022 – which nearly everyone currently expects them to do).

Source: CME Group

As of [Wednesday], traders are only pricing in a 1.9% chance the Fed will be raising the Federal Funds rate to 4%, and they are pricing in a 22.0% chance the Fed will be cutting the Federal Funds rate back down to 3%.

While analysts are still concerned that we are going to see short-term bearish pressure on earnings, this shift in interest-rate expectations is helping lift longer-term earnings expectations on Wall Street.

***As we noted here in the Digest earlier this week, there’s debate about how earnings will come in – for Q2, as well as for the rest of 2022

On one hand, yesterday’s estimate from GDPNow for U.S. GDP for Q2 is -1.9%. And this is actually up from a few days ago, when the figure came in at -2.1%.

Either way, we’re talking about an economic contraction. Despite this, a different story is emerging with medium-term earnings estimates.

John and Wade tell us that while analysts have lowered their expectations for Q2 earnings, something different is happening with forecasts for the remainder of 2022.

From John and Wade:

…Analysts have actually raised their S&P 500 earnings per share (EPS) expectations for the remainder of the 2022 calendar year by 0.8% (see below).

          It may not seem like a huge change, but at this point, the trend is more important than the magnitude of the change.

The fact that analysts are raising their forecasts for the calendar year 2022 is encouraging.

Q2 earnings season begins next week. We’ll be watching closely to see how guidance is shaping up and whether that supports this earnings growth forecast for later in the year.

***A bird’s-eye view of the S&P

Before we wrap up, let’s look big-picture at the S&P.

First, the one-year chart without any commentary.

Now, what do you notice about all the bullish moves so far this year, with the exception of the most recent one?

They’ve all either been virtually straight up, or they didn’t experience a meaningful attack by the bears, which they successfully defended by carving out a “higher” base, then continued to push north to set a new high.

See for yourself…

(I don’t consider the pullback in the March rally to be “meaningful.”)

But if we zero in on what’s happened since mid-June, we see the potential for a different type of bullish move emerging.

In short, in mid-June, the S&P hit a new low of roughly 3,650, then bounced hard to about 3,900.

It then pulled back below 3,800. That’s a substantial drop, far more than the tiny pullbacks in past bullish efforts this year.

But then, at this support level of around 3,800, the S&P mustered strength and has been pushing higher since.

If it pierces the 3,925ish level, it will overtake June’s high, setting a new pattern of “higher lows and higher highs.”

If that happens, it will be the first time we’ve seen this type of strength from the S&P all year long.

In other words, we’ll have real evidence that, at least for now, the S&P is carving out a base. And that’s reason for optimism.

Here’s the final word from John and Wade:

This bottom has a much better chance of holding the more analysts start to raise their longer-term earnings estimates.

We’ll be watching longer-term earnings estimates and Federal Funds rate expectations to gauge just how bullish Wall Street is becoming.

Have a good evening,

Jeff Remsburg