A lower than expected CPI release on Wednesday morning sent the stock market rocketing higher.
But has anything really changed?
And does it mean anything for our bearish stock market outlook and strategy?
Bloomberg made an issue of “core” inflation. Core inflation is the rate of price increase in consumer goods excluding food and energy.
There was a downtick in the annual growth rate from 2.35% to 2.2%, but it’s still near the top of the range of the past 20 months. The trend of the total index is remarkably intact.
Bloomberg explained that stock futures rose “as investors weighed the outlook for Federal Reserve interest-rate increases following the data. While the moderation partly reflects a near-record 1.6 percent monthly drop in apparel prices, a component that tends to be volatile, the broader slowdown follows a surprise decline in producer prices and suggests the path of inflation could be softer than some people expect.”
The report went on to speculate further about the reason for the rally. “Fed policy makers are widely expected to raise interest rates later this month, though a more persistent slowdown in inflation could affect their outlook for future increases.”
In other words, the rally was based on the idea that the Fed might not tighten as fast or as much if inflation is really slowing. It’s perfectly obvious to us that it isn’t.
But if that was the impetus for bulls to buy and bears to cover their shorts, then the rally was driven by a false narrative.
Bond traders obviously knew it. By the end of the trading day, the 10 year yield was right back up to where it closed on Tuesday at 2.96%. On Friday the 10 year hit 3%, then backed off a tick.
And what about the supposed surprise slowdown in producer prices? Let’s look at producer prices for core finished consumer goods, just one step in the supply chain before retailers push the product out the door.
Here again, there’s no evidence of a material change. The Finished Goods Core PPI rose 2.8% year over year in August vs. 2.9% in July. That’s hardly a slowing. In fact, the number has been between 2.7% and 2.9% for the past 10 months.
Since Inflation Isn’t Slowing, Here’s What to Do
The idea that inflation is slowing just isn’t supported. Furthermore, the conjecture that it might be slowing is useless, and not supported. The recent rally was based on pure “hopium.” With liquidity tightening, it isn’t sustainable.
There’s simply no reason in the CPI data to believe that the Fed will back off from its tightening regimen. The longer the market stays high and the more it rises, the greater the risk of a severe adjustment.
From the standpoint of technical analysis, this rally is setting up to be a test of last week’s high of 2913 on the S&P 500.
Late on Friday it was still showing signs of trying to get there. A failure to materially exceed 2913, followed by a decisive break of the short term uptrend support now around 2895, would suggest that the top is in.