Running of the Bulls
Bullish sentiment was the star of the show yesterday as year-over-year July CPI came in at 8.5% — below estimates and below June’s hottest read of the cycle yet at 9.1%. More importantly perhaps, the month-over-month reading was 0.0%, indicating no movement upward at all (on headline CPI). Even the core CPI data surprised to the downside for July.
The obligatory hedging statement is: this is only one month of cooling and one month does not make a trend. We need to see this for at least three consecutive months before the Fed feels satisfied enough to take a less aggressive stance. But, we have to start somewhere, and this is a decent start.
Uno, Dos, About Face
Markets were waiting for a reason to justify the recent rally, and at least some encouragement that the “peak inflation” calls were correct in June. With both of those boxes ticked yesterday, the rally that ensued was a powerful one with the S&P up 2.1% and Nasdaq rising 2.9% to clock in a 20.8% rise from its recent low on June 16th.
We can’t decidedly declare victory with inflation still at 8.5%, but we can look at prior inflation regimes and see how the market did during each to try to understand the risk/reward as investors. The chart below shows different ranges of headline CPI data and the corresponding average forward 12-month return on the S&P 500.
I’ve long believed that there was such a thing as an inflation “sweet spot” between 1-3%, where the market could generally rise without much worry about whether the economy was too hot or too cold. This creates more flexibility around the Fed’s 2% target and removes the labels of “good” or “bad” from anything that isn’t exactly 2%.
The data largely agrees with that theory, with the 1-3% bucket exhibiting higher average returns than every other bucket except the >10% range. But let’s be clear…that >10% bucket is an extreme environment that typically doesn’t last long, and has a host of other consequences that I’d prefer to live without. Also, only 6% of the 1,124 observations fall into that range.
The only problem here is that we’ve got a long way to go before we reach the top end of that range and hit 3% on headline CPI.
Quizás, Quizás, Quizás
Although I was, and still remain, somewhat skeptical of the swift rise we’ve seen in markets since mid-June because it feels more like risk-on multiple expansion (i.e., not fundamentally driven), I standby my statement that investors should be in the market and out of cash before the end of summer.
In Spanish, the word “suave” translates to “soft.” Rarely do we wish for softness in markets, but in the case of the Fed’s current goal, markets are starting to believe in the possibility of a soft landing. If we call it a “suave landing” it sounds more like a game of skill than a happy accident. No one truly knows what’s going to happen, but I believe that the remainder of 2022 can be characterized in markets as a period of “suave landing” upside.
That said, if you’re familiar with the actual Running of the Bulls that takes place in Pamplona, Spain each summer, you know it’s far from a peaceful jog through the city. We’re still being chased by the angry animal that is inflation, and our heart rate is still elevated, but the race is underway. And the further we get without meaningful injury, the more likely a successful finish becomes.
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