The Consumer Price Index climbs just 4% … what the market expects from the Fed tomorrow and in July … why “surprises” favor the bulls … guidelines to help you in today’s market
Another month, another drop in inflation.This morning we received news that the Consumer Price Index rose just 4% year-over-year in May. This is the lowest level in nearly two years. For the month, the increase came in at just 0.1%. These numbers are broadly in-line with expectations.As I write Tuesday mid-afternoon, Wall Street is cheering. All three indexes are up solidly, with the Nasdaq leading the way, up almost 1%.But while the cooler inflation reading is good news, investors would be wise to dive into the details beyond just the headlines. After all, the headline numbers we just quoted aren’t what the Fed finds most important as it makes its interest rate decisions. Instead, the Fed watches so-called “core” inflation, which strips out food and energy prices.So, what are those specifics?Here’s CNBC:
Excluding volatile food and energy prices, the picture wasn’t as optimistic.So-called core inflation rose 0.4% on the month and was still up 5.3% from a year ago, indicating that while price pressures have eased somewhat, consumers are still under fire.
For more context, let’s look at core CPI data since January. Here’s how those numbers shake out:January – 5.55%February – 5.53%March – 5.60%April – 5.54%May – 5.33%.Pretty much going nowhere, right?However, over this same period, headline CPI fell from 6.35% in January to today’s reading of 4%. That’s an obvious downward trajectory.But instead of focusing on stubborn core inflation, which is what the Fed watches, Wall Street is cheering the decline in headline inflation, viewing this as the final nail in the coffin for the “Fed pause” decision. In fact, in the wake of this morning’s data, the CME Group’s FedWatch tool now puts the odds of a Fed interest rate “pause” tomorrow at 94%.Even if Federal Reserve Chairman Jerome Powell wants to hike rates at the conclusion of the Fed’s June meeting tomorrow, this degree of market conviction is going to make it tough for him.Here’s our hypergrowth expert Luke Lango explaining why in his recent Daily Notes from Early Stage Investor:
The Fed will likely pause its rate-hiking campaign on Wednesday. After a slew of fresh data showed that both inflationary pressures and expectations are crashing back to 2%, the futures market has begun pricing in an 80% chance for a pause this week. [These odds have climbed to 94% since Luke wrote this.]That is important because the Fed doesn’t like to surprise the market. If the market strongly expects a pause – which is the case – then the Fed is very likely to deliver.
If the Fed does hold rates steady tomorrow, the question is whether it will be a “pause” or a “skip”
Tomorrow concludes the June meeting of the Federal Open Market Committee (FOMC) where we’ll get the latest policy update.As we just noted, the widely-held expectation is that – after 10 straight hikes and 500 basis-points of rate increases – the Fed will finally stop raising interest rates…for this month, at least. It’s the long-awaited “pause.”But whereas two months ago, Wall Street viewed this “pause” as coinciding with an interest rate “peak,” that’s no longer the case. An increasing number of Wall Street traders view tomorrow’s anticipated pause as just a “skip” before returning to hikes in July.We can see this by returning to the CME Group’s FedWatch Tool.As I write Tuesday, the odds of another quarter-point hike in July stand at 61%. There are even nearly 4% odds on a half-point rate-increase.
Will the interplay between market expectations and Fed actions goose or gut the stock market?
In the long-term, the quality of earnings drives the market. But in the short-term, the greatest influence on price is a surprise to the dominant market expectation.For example, during a company’s earnings report, it might reveal that it lost $0.10 a share. Long-term, the market will punish the stock price of this company (if such losses persist) since the business is losing money.But if the dominant expectation for that earnings report was the company would lose $0.15, well, a loss of only $0.10 is a positive surprise. The stock price is likely to jump higher even though it’s a long-term loser.As we look ahead to tomorrow’s policy decision, as well as clues for what the Fed might do in July, the market’s dominant expectation is critically important. If the Fed’s actions contradict those expectations, we could be in for fireworks…for good or bad.On the downside, the biggest risk comes tomorrow. With the market putting near-100% odds on a Fed pause, if Fed hawks win the day and the Fed decides to go with one more hike, Wall Street is in for a selloff.This is hardly out-of-the-question. For example, just three weeks ago, Dallas Federal Reserve President Lorie Logan said:
The data in coming weeks could yet show that it is appropriate to skip a meeting. As of today, though, we aren’t there yet.
Wall Street has discounted this perspective because since Logan made this comment, we’ve heard more dovish commentary from other Fed members. But let’s see this for what it is – it’s Wall Street choosing to buy into the bullish narrative instead of the hawkish one.
On the upside, the dominant expectation is for the Fed to return to rate hikes in July (assuming they pause tomorrow).So, if Powell sounds dovish in his press conference tomorrow and gives Wall Street any reason to believe that the Fed is more optimistic about inflation than previously expected, this “bearish” dominant narrative for July would be foiled, and the market could erupt higher.
As we stand today, a surprise move to the upside would likely be far bigger than a surprise to the downside
After all, if the Fed disappoints tomorrow, investors will throw a tantrum, but we know a pause is coming at some point. The downside move would be somewhat contained, and even interpreted as a buying opportunity by bulls.But if the Fed gives us reason to believe it’s more dovish than previously believed, we’re going to see a frantic scramble as record amounts of cash move back into the market. As my colleague and InvestorPlace’s Editor in Chief Luis Hernandez wrote in Saturday’s Digest:
[Many investors have been] sitting on the sideline waiting for the “all clear” signal.One look at the amount of cash on the sidelines tells you folks are still holding out. Below is the chart from the St. Louis Fed showing total assets held in money market funds.
There are more funds in money markets now than during the pandemic-induced recession of 2020.I suppose inflation will do that.
Here are more details from Reuters:
Cash on the sidelines is plentiful: U.S. money market fund assets hit a new record of $5.8 trillion last month, while cash levels among global fund managers remain high relative to history, according to the latest survey from BofA Global Research.And while computer-driven strategies have been piling into the market for months, according to Deutsche Bank, positioning among discretionary investors — a cohort that includes everyone from active mutual funds to retail investors — is lighter than it has been 74% of the time since 2010, the bank’s data showed.
If this cash hoard begins flowing back into to the market, it’s likely to fuel a major rally – even if such a rally is hated
Consider the psychology…For Main Street investors, few things are more painful than watching your neighbor making money hand-over-fist in the market while you’re sitting on the sidelines.Older investors will remember this classic Newsweek cover from 1999’s Dot Com bull market, in which a man whines that “Everyone’s getting rich but me!”:
For professional money managers, it’s even worse.If they underperform their professional competition or their investment benchmark, the consequences are usually either cash outflows from their funds, and/or losing their job.So, even if Main Street investors and the professional money managers don’t feel all that bullish, the pressure to act bullishly could prove irresistible if the market pushes higher and fear of missing out (FOMO) becomes the dominant market emotion.Here’s Bloomberg on that note:
The old mantra of “Don’t fight the Fed” is turning into “Don’t fight the FOMO.”People will hate on this stock-market rally. They’ll say it’s fake, or just a handful of tech stocks making everything look better than it is. But the bottom line is, the S&P 500 and the Nasdaq — and especially the Nasdaq 100 — are up significantly, despite all the naysayers, and that alone is enough to drag cash in.“FOMO is a very powerful force,” Tallbacken Capital’s Michael Purves said today. “If you missed the rally, you sort of feel obligated to” put aside your qualms about risk and get into the market. That’s an emerging theme of traders working through a mid-2023 reset in which the tech-led run-up is even showing signs of spilling into other sectors.
In recent Digests, we’ve tried to help readers respond to the challenge of wading into a hated bull market through a variety of suggestions
One, stop viewing the market as one big monolith that rises or falls in unison.Instead, focus on individual sectors and/or stocks that might present fantastic buying opportunities, even if you’re less comfortable with the fundamental set-up of the broad market.Two, focus on artificial intelligence (AI).This is not a fad. This is perhaps the most transformative technological advancement we’ll see in our lifetime. Well-placed investments today in the AI leaders of tomorrow will create literal fortunes for patient, wise investors. Our experts Louis Navellier, Eric Fry, and Luke Lango have all been positioning their readers in top-tier AI stocks, and this will only snowball in the weeks/months to come.Three, if you’re nervous about the market’s fundamentals today, adopt a trading mindset.In other words, free yourself from the mental obligation of viewing a stock purchase as a long-term, buy-and-hold addition to your portfolio. Instead, view stocks as wealth-generating tools, which you’ll use as long as they’re climbing, making you money (even if their fundamentals are questionable); but as soon as they begin falling, you’ll simply trade in that stock for a new “tool” that’s better able to help you grow your wealth.Adopting these mindsets will help prepare you for whatever the Fed does tomorrow, as well as in July.For now, headline inflation keeps dropping, optimism continues growing, and the market keeps rallying. Let’s make money while we can.Have a good evening,Jeff Remsburg
