This week's decline in two key inflation indicators gave investors an excuse to buy stocks. At this point, we have retraced 50 percent of the losses from the beginning of the year. The thinking behind this recent move higher is that inflation is coming down, and the Fed no longer needs to maintain its super tight monetary policy stance. Is that a good bet?
That is not the case, according to several talking Fed heads that were trotted out by the U.S. central bank to address the markets on almost a daily basis this week. Even the most dovish of members continued to stress that nothing has changed in their thinking. To a person, each Federal Reserve member stressed that the market should expect another interest rate hike in their September 2022 FOMC meeting. In addition, the reduction in their balance sheet will continue unabated.
Clearly, investors do not believe these warnings. The bulls are confident that inflation will continue to decline to the point that the Fed will change its mind. As such, that belief is enough to support if not justify further purchases. It certainly is an enticing story considering the data.
Everyone should have been pleased with the inflation data. It points to a peak in inflation. Both the Consumer Price Index CPI), and the Producer Price Index (PPI) came in lower than expected. However, both the CPI rate of plus-8.5 percent, and the PPI gain of 9.8 percent are still a long, long way from the Fed's official target of 2 percent inflation. Even if we had zero additional inflation for the remainder of the year we would not reach the Fed's 2 percent target.
Some bullish investors may also be betting that since we won't know what the Fed is going to do until September, markets can continue to rock and roll at least for another week or two. As it is, the bond vigilantes have already reduced their expectations of how much the Fed will raise rates from 75 to 50 basis points at that meeting.
Most of the decline in both the CPI and PPI can be credited to the price decline in energy. Nationwide, we are seeing gasoline prices below $4 a gallon, while oil has dropped recently to below $90 a barrel. But here's the rub.
The Fed has little influence over the future price of oil. Geopolitical events, currencies, and global supply and demand are much weightier factors in determining where the price of oil goes next. What if oil climbs above $100 a barrel next week? What will that do to the future CPI report, and how would markets handle that?
As I have been advising readers for weeks my target for the S&P 500 Index on this bounce was 4,100 to 4,200, give or take a few points. This week we hit 4,257. Now what?
I warned readers back in June 2022 that after this relief rally, "somewhere in middle to late August," we would start a decline that could take us back down to 3,800 to retest or slightly break the year's lows. That remains my forecast.
However, this decline will be accomplished in fits and starts. Investors are caught in the throes of greed and FOMO. So, for example, next week we could see a series of shallow pullbacks, only to have those who have missed this rally buy the dip. These Johnny-come-latelies will expect even higher highs. They may even push us back toward 4,250 on the S&P 500. However, by the end of next week we should be declining.
This kind of market action could continue for the next few weeks. As it does, I would expect the markets to be making lower lows, and lower highs. By September 2022, we will likely see the lows I am forecasting. What is my thinking behind this rather gloomy prediction?
I expect oil prices have bottomed for now and will rise over the next few weeks. Geopolitical tensions could heat up as well adding tension to global markets. The Fed will continue to tighten, despite the atmosphere of hopefication that has infected investors right now. Corporate earnings will continue to fall and profit warnings will become more commonplace as the economy continues to slow.
None of my thoughts are original. I am simply echoing the bear case. The only difference is that I have been predicting this since December 2021.
Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at email@example.com.
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