The stock market is crashing right now, and it’s downright ugly. Both the Nasdaq and S&P 500 dropped into correction territory this past week, marked by a 10% decline from recent highs.
But there is one very good reason to believe stocks will rebound soon: inflation.
For the past 18 months, inflation has been stocks’ primary driver. When inflation rises, stocks fall. When it falls, stocks rise.
From January 2022 to June 2022, inflation roared higher, causing stocks to crash. Then, from June 2022 to June 2023, inflation consistently dropped. And stocks staged a big year-long rally. But over the past few months, inflation has reheated. Consequently, stocks have fallen into correction territory.
Inflation and stocks have been perfectly inversely correlated over the past 18 months.
If that relationship holds true going forward, then stocks should start rallying again soon.
Inflation Data Indicates a Rally Is Coming
That’s because after rising throughout late summer, inflation is now falling once again.
On Friday, we received September’s personal consumption expenditures (PCE) report. And it showed that PCE inflation dropped from 3.5% to 3.4% after rising throughout the summer. Meanwhile, core PCE inflation dropped from 3.9% to 3.7%.
More importantly, this renewed trend of falling inflation has staying power.
The Cleveland Fed’s highly accurate Nowcast model sees both PCE and core PCE inflation falling sharply in October, too.
In other words, the disinflation trend is back.
That suggests that the stock market rally should return soon.
And it could happen as soon as this coming week.
The Final Word
The Fed delivers its next interest rate decision on Wednesday, Nov. 1. The overwhelming consensus is that the central bank will not hike rates. The Fed has never acted counter to the consensus expectation. Therefore, it should not hike rates this Wednesday. And because that’s already expected, the market probably won’t react much to that decision.
However, the market will likely violently react to Fed Board Chair Jerome Powell’s post-FOMC commentary.
Here’s the thing about Powell. He’s acted as the “great mediator” for the economy and expectations over the past 18 months.
Whenever the market gets too spooked, he reenergizes investors with dovish commentary to help the economy avoid a recession.
And whenever the market gets too excited, he dilutes that enthusiasm with hawkish commentary to help the economy avoid reinflation.
Right now, the markets are spooked. We’re in correction territory for the first time this year. This is as spooked as markets have been in 2023.
And that means Powell is likely to come out with dovish commentary and help save this crushed market. And importantly, he can afford to do so because disinflation has returned.
The stock market turnaround is close.
