Stock markets staged a massive rally last week on the news that inflation figures softened during October. The S&P 500 was up 5.9%, and the NASDAQ was up 8.1%.
After a dismal year for just about every asset class, this rally was a breath of fresh air. The hope here is that if inflation figures continue to fall, then the Federal Reserve will (at some point soon) be more accommodative, which is a boon for stocks and other risk assets.
The prospect of disinflation is enticing cash-rich investors and others that have been sitting on the sideline, especially those stocks that have been battered (such as the tech-heavy NASDAQ index).
Furthermore, the market does not perform well when there is a substantial amount of uncertainty. The past few weeks have helped to resolve two major “unknowns” out there – the 2022 election cycle and what forward-looking rates will look like.
We Saw This Coming
Earlier this month, we published a blog post and a YouTube video highlighting why we think the inflation rate will fall faster than most anticipate. So far, while it is still early, inflation levels have been falling faster than predicted.
To be sure, the year-over-year basis is still very high. CPI is up 7.7% from a year ago, and core CPI (which excludes energy and food) is up 6.3% versus a year ago.
Inflation is still a significant problem for all. 8% YOY inflation is no reason to celebrate, though this does signal a light at the end of the tunnel.
At this point, the big question is whether October’s inflation figures were a fluke or if it is the beginning of a softening inflationary trend. It is only one datapoint and one month does not indicate a trend. We will need to see how November’s and December’s CPI figures look to see if this really is the start of a trend.
As optimists (and data-driven individuals), we think the disinflationary forces at play will continue to bring the overall inflation rate down.
These disinflationary forces, as a recap from our earlier piece, include the decline of the money supply (M2), falling housing prices, falling container shipping rates, falling commodity prices, and the easement of the global supply chain. I highly recommend checking out this piece to understand these forces better.
There is still a ways to go before inflation hits the Fed’s target rate of 2%, so we expect the Federal Reserve to continue its aggressive fight. This means volatility will continue to reign. We are not out of the woods. Nonetheless, the tide is turning, and hopefully, the worst is behind us.
How This Impacts Markets
The million-dollar question is if stocks have hit their low. Of course, we don’t know for sure, but there is an increasing possibility that it might have.
Though, keep in mind that we have yet to enter into a recession, which we think will occur in early 2023. We still have this to contend with, but markets have a tendency to fall, bottom out, and rebound even before a recession technically begins. More on this in a future blog post.
This year’s max drawdown for the S&P 500 occurred on October 12th, at -25.4%.
The markets rebounded somewhat from these figures thereafter but really didn’t start to rally until Thursday, November 10th, when October’s CPI figures were released. As I write this, the S&P 500 is down -17% for the year.
Now that the election cycle is (mostly) behind us and inflation data is improving, investor optimism is starting to percolate. Long-duration assets that suffered tremendously this year are finally getting a bid. Tech stocks, long-dated government bonds, and other beaten-up assets are garnering interest.
Mind The Gap
Thursday’s market rally is a great reminder of why one should not abandon their plan and completely sell out of the market. It is tempting to be safe and sit on the sideline while chaos ensues, only to buy back in once “things look more stable.” However, by the time the market is on more stable footing, your buying opportunity has likely passed.
When CPI figures were published before the market opened on November 10th, stock futures roared. This means that stocks “gapped” up when the market opened, preventing investors from buying at lower prices. This is where a significant percentage of stock gains are made – after hours.
If you were already invested, then no worries – you took the express lane to higher prices.