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It has been a superb 12 months for inventory market traders with the S&P 500 (SP500) returning greater than 17% so far and almost 30% increased from the 2022 lows. The mixture of a resilient economic system, easing inflation, and powerful company earnings stunned a variety of very good folks from this time final 12 months. We’ve been bullish throughout this run and might make the case that there’s extra upside forward.
On the similar time, it is the perma-bears which have been caught flat-footed on the unsuitable aspect of the narrative. We are able to look again at a number of “bear traps” in latest months, the place the market was in a position to climb over the proverbial wall of fear in 2023. Speaking factors that appeared to sign the beginning of a giant market correction did not pan out.
We carry this up as a result of we’ve got one other one in all these huge moments arising. The August CPI report, set to be launched on September thirteenth, will assist set the market tone available in the market for the remainder of the 12 months with implications for the subsequent steps in Fed coverage.
Our name is {that a} favorable inflation studying, notably on the core aspect, ought to be sufficient to maintain the Consumed maintain and shut the door on additional charge hikes. The setup right here is for shares to regain momentum from the latest dip and in the end reclaim the latest highs.
![SPX metrics](https://static.seekingalpha.com/uploads/2023/9/8/49782598-1694185839113147.png)
supply: Finviz
August 2023 CPI Report Preview
Once we speak in regards to the “delicate touchdown” within the economic system, our interpretation of that’s the Fed’s means to carry down the CPI towards the two.0% goal, with out wrecking the economic system. What we have seen is that following a string of 11 charge hikes since early 2022 taking the Fed funds charge from zero to five.5%, is that the technique is working.
The final reported July inflation charge at 3.2% is an evening and day distinction in comparison with situations on the cycle peak final 12 months when the CPI hit 9.1%. The headline charge has benefited from sharply decrease vitality costs over the interval whereas pressures from different classes like meals have additionally settled. We must always get extra proof of that with this replace.
Ignore the uptick within the August headline CPI annual charge
- For the August CPI, the present consensus is for a tick increased within the headline annual charge to three.6%, in comparison with 3.2% in July.
Our take right here is that this ought to be interpreted as month-to-month variability and never indicative of an actual change in development. A latest rebound in vitality off the lows is a part of that dynamic, however not essentially regarding proper now.
It is clear to us that even with a CPI of three.6%, inflation is not a “drawback” and the Fed has already finished sufficient. There’s nonetheless a path right here for the CPI to stabilize decrease into 2024. There’s additionally the chance this determine is available in under expectations.
![SPX metrics](https://static.seekingalpha.com/uploads/2023/9/8/49782598-16941868125663252.jpg)
supply: tradingeconomics
Naturally, we count on market bears to run circles round this determine as proof Fed is shedding management and might want to proceed mountain climbing, however that will be a mistake because it misses the larger image.
Drop in Core-CPI is the Bullish Growth:
- From 4.7% in July, the present market estimate is for the core CPI in August to fall to 4.3%.
Right here the setup with the core-CPI, which excludes meals and vitality, is extra favorable as a result of parts on that aspect of the buyer worth basket have been seen as “sticky” or stubbornly excessive all 12 months and are lastly making a much bigger transfer decrease.
We count on a constructive market response to the core CPI reaching its lowest degree since 2021 since that is the development the Fed can be paying extra consideration to, particularly at this stage within the cycle. The transmission of the tightening finished over the previous 12 months is ongoing.
![SPX metrics](https://static.seekingalpha.com/uploads/2023/9/8/49782598-1694189469958893.jpg)
supply: tradingeconomics
Falling Shelter Costs But To be Captured in BLS Knowledge
The rationale we’re assured that core will proceed to development decrease is by observing an obvious divergence between personal market “real-time” benchmarks towards the official Bureau of Labor Statistics (BLS) CPI knowledge. Whereas many indicators recommend house costs and rents have peaked, BLS has lagged primarily based on its measurement intervals and survey assortment methodology.
As that converges decrease going ahead, one of the vital cussed and elevated parts of the CPI shelter which climbed by 7.7% in July ought to right and drag decrease all the index. This could additionally assist steadiness any volatility in vitality costs.
![SPX metrics](https://static.seekingalpha.com/uploads/2023/9/8/49782598-16941916472900565.jpg)
supply: BLS
Trade knowledge from “Apartment List” reveals that the nationwide hire index in August contracted for the primary time since 2020, falling by -1.2% y/y. The identical report additionally reveals that 72 of the highest 100 main cities within the U.S. are presenting unfavourable year-over-year hire progress, with a climbing quantity suggesting extra draw back for the index degree going ahead.
Affordability is low, shopper spending is pressured, which implies there is not a lot of a cause to see why rents and different core classes’ costs are instantly going to reverse increased.
![SPX metrics](https://static.seekingalpha.com/uploads/2023/9/8/49782598-16941921023837297.jpg)
supply: Condominium Record
When it comes to house gross sales, the traits are additionally encouraging with worth progress turning flat in accordance with the S&P CoreLogic Case-Shiller Index in June and even barely unfavourable on an annual foundation with knowledge from Realtor.com.
Once more, these drops are in sharp distinction with the 7.7% improve in shelter costs seen within the July CPI knowledge. We count on the August report to start higher reflecting these present market situations.
![SPX metrics](https://static.seekingalpha.com/uploads/2023/9/8/49782598-16941929658874516.jpg)
supply: Realtor .com
That is additionally the case within the used automotive market, the place we prefer to comply with the “CarGurus Index” which reveals the typical worth of used vehicles is down by -0.8% just over the last 30 days, and -7% over the previous 12 months. This index is nice as a result of it tracks hundreds of thousands of listings patrons are seeing proper now.
That is one phase that continues to be skewed going again to pandemic provide shortages and manufacturing stoppages. As new automotive inventories construct, mixed with the impression of excessive mortgage charges and customers already below strain, automobile costs inside the CPI are one space we’ve got an additional draw back.
![SPX metrics](https://static.seekingalpha.com/uploads/2023/9/8/49782598-16942313550231514.jpg)
supply: cargurus
Oil Worth Rally Not But Regarding
What has raised some eyebrows is the continuing rally within the worth of oil, with WTI crude (USO) presently round $87/bbl, up from as little as $67/bbl in June. Naturally, a few of that ought to be captured within the vitality element of the CPI for August, even because the annual development stays unfavourable.
In our view, oil solely turns into a trigger for concern above ~$100/bbl as a degree that might kickstart a brand new spherical of cost-pull inflationary traits, and we’re not there but. The present nationwide common for the worth of gasoline at $3.80, is properly under the height in 2022 when ran above $5.00 a gallon.
Circumstances final 12 months that took the worth of oil briefly above $130/bbl had been distinctive as they had been pushed by international provide chain disruptions and even the preliminary uncertainty of the Russia-Ukraine conflict. We’re simply not seeing the availability crunch vital for oil or gasoline to make that sort proper now.
So whereas oil can nonetheless rally a bit increased from right here, it isn’t fairly a game-changer by way of its implications for the CPI, particularly this upcoming August report. The way in which we see it’s that the Fed is extra involved in regards to the elements of inflation it might probably management with core indicators taking priority at this stage within the cycle.
![SPX metrics](https://static.seekingalpha.com/uploads/2023/9/8/49782598-16941938594010334.jpg)
supply: finviz
What in regards to the Fed?
Exterior of a spectacular shock increased to the CPI knowledge coming in sizzling, the overwhelming consensus is that the Fed will hold charges regular on the subsequent FOMC set for September twentieth. The latest August payrolls report confirmed an uptick within the unemployment charge together with messaging from Fed officers suggesting they’re content material to attend it out and take up a number of extra months of knowledge.
Then again, the query turns into extra fascinating searching to the top of the 12 months, the place the market is almost cut up on the place the Fed Funds charge can be set on the December assembly.
In response to the present market implied chances primarily based on Fed Funds charge futures, there’s a 53% probability the Fed will maintain on the present charge by year-end, in comparison with a forty five% probability of a hike. We’re within the maintain camp.
![SPX metrics](https://static.seekingalpha.com/uploads/2023/9/8/49782598-1694194731504267.jpg)
supply: CME FedWatch Software
The decision we’ve got is that the Fed is completed, and additional hikes are pointless for the CPI to proceed trending decrease. The Fed has stated it’s data-dependent, and the excellent news right here is that the information on the inflation aspect has turned out properly. This situation ought to be constructive for the inventory market, particularly whether it is accompanied by continued resiliency within the economic system as we’ve got seen all 12 months.
The way in which to see it enjoying out is that larger market confidence that the Fed is completed mountain climbing as a result of the CPI is trending decrease by the top of the 12 months, ought to work to push market charges and bond yields decrease.
Wanting on the 10-year Treasury as a benchmark, room for the yield to tug again in direction of 3.75% as our year-end goal would additionally enable the U.S. Greenback to weaken as a backdrop of extra constructive threat sentiment. As a aspect observe, we see worth in long-term bonds general.
The opposite aspect to the dialogue is the bearish case, the place the inflationary outlook deteriorates and inflation expectations climb increased for any variety of causes. This might power the Fed to renew mountain climbing and switch extra hawkish, creating a brand new spherical of volatility in bonds and shares as the important thing threat to think about.
By this measure, market bears are kind of betting on the CPI and core-CPI to return in hotter than anticipated, as a catalyst for the market to reset expectations decrease.
![SPX metrics](https://static.seekingalpha.com/uploads/2023/9/8/49782598-16941977563054266.jpg)
supply: CNBC
What about Shares?
We stay bullish on shares and see the next elements as driving additional upside by year-end.
- Easing inflation by a falling core CPI.
- Stability in charges because the FED stays on maintain, with room for charge cuts in 2024.
- Resilient financial indicators between a steady labor market and modest financial progress, brushing apart fears of a recession.
- Continued company earnings momentum entering into the Q3 reporting season subsequent month.
- Revisions are increased to earnings estimates into subsequent 12 months.
![Chart](https://static.seekingalpha.com/uploads/2023/9/9/saupload_93ebdcd5d316140d0f1b4981771e5adf.png)
Ultimate Ideas
We talked about the bear lure in the beginning of the article. On this case, anybody anticipating a giant selloff simply because the annual headline CPI charge ticks increased within the August report could discover themselves dissatisfied. We count on the traits within the core CPI to steal the present, which ought to be sufficient to maintain the Fed from mountain climbing on the subsequent FOMC as a extra bullish growth.
The Fed has stated a number of occasions they’re data-dependent, and that is excellent news for the inventory market because it pertains to the indications that matter. With a few of the main U.S. fairness indexes off a number of proportion factors from their highs, the decision right here is to purchase the dip into the August CPI report.