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4 key market topics to determine where we are going

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Last week I talked about the likelihood of the S&P 500 (SPY) staying in range due to the mix of bullish and bearish forces. One of the bullish forces was the resilience of earnings, which remained positive (+6% in Q2) despite adverse conditions. Another example was the signs that inflation may have peaked, and there was hope that August would continue the trend of moderating inflation on a monthly basis, which would be a leading indicator of a Fed pivot (more specifically, a slowdown of the rate of increases). Of course, the inflation outlook is much different after Tuesday’s CPI report. In today’s commentary, I want to focus on why this development is so important. Next, I want to talk about its impact on our strategy. After that, we will go into an overview of some market topics. Read on below for more information….


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(Enjoy this updated version of my weekly commentary published on September 16)e2022 of the Newsletter on POWR Shares Under $10).

For the past week, the S&P 500 (SPY) is down 2.5%, although we are down more than 5% from Monday’s closing price.

Monday seems like a long time ago, as the S&P 500 was above 4,100 and looked like it would continue to rise if the inflation rate softened. There were also reasons to expect inflation to continue its trend from July, with a weaker figure.

This was due to lower commodity prices and weakness in terms of leading inflation indicators.

While some areas showed lower prices, such as gasoline and vehicles, other areas continued to show rising prices, such as services and rents. And these are especially the areas that correlate with ‘sticky’ inflation, which is exactly what the Fed wants to avoid.

The hot inflationary pressures were enough to wipe out any gains from the past week. Sometimes the market can overreact, but I don’t think this is one of those times as falling inflation is essential to any bull case as it brings relief to the rate front and a boost to margins.

On the other hand, stabilizing inflation at this high level means that the Fed will remain aggressive and restrictive monetary policy for an extended period of time.

In fact, the debate has been shifted for the next FOMC meeting. Prior to the CPI report, the debate was about 50 basis points or 75 basis points. Now it is between 75 and 100 basis points.

Last week I felt the bullish and bearish forces balanced. This shifts the dynamics in favor of the bears, as it reduces the strength of the bullish tailwind from falling inflation and leads to a more aggressive Fed for longer.

If we parse the words of the Fed, it could be said that 2 months of lower monthly inflation could cause the Fed to slow its rate hikes. The monthly core CPI gain of 0.6% resets the clock.

The overall picture of the economy and earnings was remarkably resilient. Earnings grew 6% in the second quarter and is expected to grow about 5% in the third quarter. But these figures are no longer calculated with the assumption of higher rates.

One more comment on this. These rate hikes end in 2 ways: either inflation breaks before the economy does, or inflation breaks and the economy breaks.

The first scenario can’t be ruled out because it’s exactly what happened this year, but I think the probability of the latter has risen sharply.

Strategy

If we had gotten ‘good’ inflationary pressures, I think we could retest the August highs of 4,300. A bad reading and our next big test will be the recent mid-June low at 3,600.

Therefore, we are again switching to a more defensive strategy and will try to use power sources to reduce exposure.

On the long side, we will continue to identify fundamentally strong stocks for long-term and short-term ownership, with low risk. But the greater focus will be on maintaining our firepower when more offensive tactics are rewarded.

Market topics

Now let’s take a look at some key market topics…

Energy: We see continued weakness in oil and energy prices. However, there are some extenuating circumstances.

First, the US is a seller of oil because it is selling some of its strategic petroleum reserve (SPR), and the Chinese economy continues to run at full capacity, hurting oil demand.

So this is positive, but it’s fair to recognize that there are unusual circumstances.

Gold and Silver: Precious metals had some sort of lose-lose situation when entering the CPI report. A soft number probably means a risk-on stock market (SPY) and investors want to buy technology, not precious metals.

A hot number means a tighter Fed, bigger rate hikes and longer higher.

All of these paths are bearish for precious metals. I don’t see a sufficient reason for a rally, other than an unforeseen crisis or a pivot in Fed policy.

HOPE Model: A model used to describe how tighter monetary policy circulates through the economy is HOPE. H is for housing, O is for new orders, P is for profit and E is for employment.

We are now somewhere between the O and P, as New Orders are now in expansion mode, while the revenues overall haven’t shown any signs of damage yet.

Bullish Catalysts: We’ve had 2. One is that some of the short-term extremes in sentiment and positioning have been resolved, that is, the rubber band is no longer stretched. Shorts and put holders were wiped out during this rally.

What to do?

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All the best!

Jaimini Desai
Chief Growth Strategist, StockNews
Editor, POWR Shares Under $10 Newsletter


SPY shares closed at $385.56 on Friday, down $-4.56 (-1.17%). Year-to-date, the SPY is down -18.22%, versus a % increase in the benchmark S&P 500 index over the same period.


About the author: Jaimini Desai

Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of the POWR growth and POWR Shares Below $10 newsletters. Read more about Jaimini’s background, along with links to his most recent articles.

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