Weekly Update

Inflation Has Plateaued

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Published November 4, 2022


Stock investors had a bit of a panic attack this week. The Fed Chair Jerome Powell continued hammering markets with his inflation-fighting warrior pose, a pose that most all market-watchers now agree he was late in adopting. Powell is making up for lost time, of course, by ratcheting up interest rates at a breakneck pace. The sudden acceleration has been a very cold shower for some business processes with private equity and venture capital investors reducing their activity by a third or more in the most recent quarter. Think about it. If your cost of capital has more than doubled in a matter of a few months, and you have no idea where that cost peaks, you simply stop making business investment decisions, waiting until you get at least a little clarity on the path forward. The yield curve, with short-term rates higher than longer-term rates, suggests that market participants expect interest rates to come down a bit once this near-term inflation-fighting pose relaxes.

The problem this week is that investors have seen several reports now pointing out that inflationary inputs have peaked and are now falling. Here are a few of those reports – ALL of them showing price rises abating.

Inflationary input #1 has peaked

Inflationary input #2 has peaked

Inflationary input #3 has peaked

The previous issue of out-of-whack supply chains causing inflation has essentially gone away – supply chains are back to their previous level (chart below).

Supply chains are back to their previous level

Viewing those reports, investors expected the Fed Chair to strike a less aggressive posture. When he didn’t, the market freaked out with the Russell 2000 smallcap index dropping -4% in about an hour during Powell’s testimony; and falling further the following morning (for a total near -6% swing!).

Fed posture reaction on Russell 2000 index

But with each passing day, we get closer to the end of this Fed attack on the markets. The Fed is clearly having the desired effect of pulling excess from the markets and slowing down inflationary impulses. Meanwhile, corporate earnings have generally been ok, with industrial companies – perhaps the most economically sensitive (think Caterpillar, Honeywell) – doing quite well. At worst, it’s a mixed economic outlook, not a recessionary one, with prices clearly having plateaued. Once the Fed acknowledges that, markets are poised to settle down and become more productive for long investors.

Market Update

Investors focused this week on the Federal Reserve’s latest interest rate move, due during Wednesday’s trading session. Monday saw the stock market give back -0.7% as investors approached the Wednesday Fed announcement with caution. However, Monday brought a very strong month of October to a close with the Dow Industrials posting their largest monthly gain in decades. Of course, this outstanding upside performance comes on the heels of a terrible September. So, volatility continues to be the primary impulse for traders. Another -0.4% slide Tuesday reflected caution ahead of the Fed. The Wednesday session brought massive volatility as the initial statement from the Fed appeared to confirm the bull’s thesis for slower rate rises ahead. Stocks initially zipped higher only to abruptly change direction when Fed Chair Powell began speaking. Mr. Powell indeed offered that rate rises would slow, but said they would do so from a higher level than previously thought. Those words sent stocks hurtling downward to leave the interest rate-sensitive Nasdaq with a -3.4% loss. Another -1% loss was added Thursday as interest rates jumped on the Fed news. Friday brought the monthly jobs report which showed employment remaining very strong and wages growing. The report didn’t really change the picture for the Fed and investors reacted with another volatile session. Stocks ran higher in the morning helped by the potential relaxed Covid restrictions in China. Markets gave back all the gains midday; only to recover them by the close. The +1.5% Friday gain merely recouped the Thursday loss. Of note, despite the volatility in the market, the VIX “fear” index continued falling, now down four weeks in a row. Once-leading tech/consumer stocks Microsoft and Google also kept falling, hitting their lows for this bear market as froth comes out of the tech sector.

Another volatile week found stocks giving back the prior week’s gains and struggling to build on October’s rally. The S&P 500 (SPY) shed -3.26% while the Nasdaq 100 (QQQ) suffered a -5.88% setback. Smallcap stocks (IWM) held their recent outperformance with a lesser -2.45% slide.

Warm wishes and until next week.