Last week couldn’t have ended much worse.
In case you missed it, the Consumer Price Index (CPI) showed inflation up 1% over the past month and 8.6% compared to last year. That’s bad news. However, there is a sliver of good data that the news overlooked in the otherwise-ominous report…
Here’s how inflation reports work: When government economists report inflation, they give us the headline number and a “core” number that excludes fuel and food. That may sound odd, but the argument is that core inflation is a better measure because energy and food prices fluctuate so greatly from month to month.
Normally, the two numbers are close, but lately, core inflation has been dropping, mostly because it excludes spending on gasoline. So, even when accounting for housing (about 30% of inflation), the core numbers are coming down.
Should you rush out and buy stocks because core inflation is dropping? No. However, it does help put things in perspective.
The bad news sent the S&P 500 and other major indexes back to the same lows established two weeks ago. We don’t like to see that, but this is where the big institutional investors started buying the last two times the market dropped, and we think the odds for that happening again this week are high.
In our view, a bounce seems likely starting Wednesday afternoon. There are other announcements and reports happening today and tomorrow, but Wednesday’s news will be the biggest make-or-break moment for the market.
Another Rate Jump in Our Midst
The Federal Reserve will make another interest rate decision on Wednesday at noon ET. It is almost certain that the Fed will raise the overnight interest rate from 1% to 1.5%; however, longer-term interest rates have already accounted for that. The expected rate hike shouldn’t move the market.
What is more important during a Fed announcement than the rate hike itself is what the Fed says about economic conditions, inflation, and the outlook for the rest of the year. We think recent market volatility will put pressure on Fed Chairman Jerome Powell to make some comments to calm the market. Specifically, we expect Powell to reassure investors that future rate hikes are “data dependent.”
If you aren’t a Fed watcher, the term “data dependent” is an important code word for “We’ll either stop hiking rates, or we’ll cut rates if the economy starts to slow down.”
The last time the Fed raised rates (December 2015-January 2018), that was the code they used in early 2019 to signal that they were going to slow down, which they did, and the market rallied 40%.
The point is to keep your options (pun intended) open in order to profit if the Fed does what we expect. Even a short-term bounce could be a great profit opportunity.
What You Should Do
We still like large-cap value stocks, and energy companies with exposure to natural gas should be among the best returns this year. If you waited last week until the Friday report was out — good for you. Prices among those stocks are back at some of the lowest levels compared to earnings that we have seen in years.
We also think investors are overlooking stocks in the property and casualty insurance group. It’s not sexy, but that group has doubled the returns of the S&P 500 and are still positive over the past month. We like this group because they benefit from higher interest rates, but unlike banks, reduced demand for mortgages won’t drag them lower.
After a disaster at the end of last week, investors are anxiously awaiting the Fed’s announcement on Wednesday. We expect the Fed to reassure traders that they aren’t “locked in” to raise rates forever. That announcement should lift sentiment a bit, which will be the best time for new entries.
Whether you waited to add some bargains to your portfolio or not, we suggest waiting until after the Fed report is out Wednesday before making any big changes