Opinion: Inflation is going to fall just as fast as it rose, and that’s investors’ cue to enter the stock market

When central banks, most notably the Federal Reserve these days, become too aggressive in raising interest rates, things collapse.

Believe it or not, that is bullish in the twisted thinking of Wall Street. That’s why shares rallied earlier this week.

Before you laugh about it, think about the logic. It’s not completely absurd.

Faced with a financial crisis threatening systemic risk – because a bank or securities firm “fails” – the Fed could abandon the policy tightening plan it has been working on. This would eliminate the increased risk of recession. And that would be good for stocks.

“Markets stop panicking when central banks panic,” said Michael Hartnett, Bank of America’s chief investment strategist.

But the best resistance to this thinking is investors who are selling. They believe the Fed may not have this freedom To return. Half the Fed’s job is controlling inflation – and headlines tell us that inflation is still raging.

“The inflation data from the US and the euro zone do not allow for a cautious reaction from central banks,” says Barclays strategist Ben McLannahan.

We can say that this bleak view is consensus because the mood is so bleak. However, this can still be wrong, which would mean you would make money by buying stocks now.

This consensus view is wrong in my opinion because behind the scenes – in what I call the upstream inflation numbers – we see a lot of evidence that prices are falling fast and sharply. If that has an impact on the consumer price index (CPI) and personal consumption expenditure (PCE) index, which are getting all the attention, investors will ease Fed-induced recession fears. Stocks will recover.

The extremely negative mood caused by recession worries is also a buy signal. More on that below. But first, here’s what history tells us about spikes in inflation and why it’s going to fall faster than people think.

Round trips in inflation peaks are symmetrical

Historically, the time it takes for inflation to spike is equal to the time it takes for spikes to reverse. Inflation probably peaked in March or April this year and started to warm up in April 2021. This tells us it took a year for the surge to form, suggesting inflation will return to levels that are not worrying by next spring or early summer, says Jim Paulsen, investment strategist at Leuthold, a market research group.

Strong inflation spikes are excellent buy signals. The stock market bottomed on six of the seven biggest spikes in inflation since the 1940s, when the consumer price index peaked.

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“If you buy at the peak, you’ll do damn well over the next 12 months,” says Paulsen. Waiting until inflation is under control is not the way to go.

Take the three major inflation peaks of 1970, 1975, and 1980, an era that investors compare to the present. A year after the last two, the S&P 500 SPX,
-1.02%
had increased by over 30%. A year after the first, it rose by 8.8%. On average, a year after inflation peaks, stocks rise 13% when a recession hits and 17% in a non-recession scenario.

Here are seven key trends that will drive this symmetrical decline in inflation.

1. Energy prices have fallen sharply. West Texas Intermediate Crude Oil Prices CL.1,
-0.28%
are down 30% from June. A gallon of gasoline is down 23% from its peak in the same month. Energy is central to the economy, so its price has a major impact on the prices of almost everything. There is also a psychological aspect.

“Nothing is more central to how people feel about inflation and the state of their finances in general than how much it costs to fill up their gas tank,” says economist Mark Zandi of Moody’s Analytics.

2. Commodity prices are falling fast. The S&P Goldman Sachs Commodity Price Index is down over 20% from its early June peak. Copper, steel and aluminum prices are down 31% to 48% since March. These are fundamental building blocks in economics that are not followed. But the price declines are having an impact on headline inflation.

3. Rents are falling now. A major concern is that services inflation is high. This is driven in large part by rents that are rolling over. Follow updates from CoStar Group CSGP,
+1.09%,
a great source of data on real estate trends and analysis. “We are witnessing a complete reversal in market conditions in just 12 months, from demand significantly outpacing available units to new shipments outperforming weak demand,” said Jay Lybik, director of multifamily analytics at CoStar.

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4. Retailers cut prices to shed excess inventory. target TGT,
-0.42%
made headlines in early June when it became known that prices would have to be cut in order to reduce inventories. Nike,
-1.02%
followed last week. These two aren’t the only ones overordering goods and expect the consumer preference for goods over services caused by the pandemic to persist. This inventory clearing will soon be reflected in the inflation headlines.

5. Supply chains are improving. Recent Fed surveys show inventories rising and delivery times falling. Freight rates are down a third from recent highs. The business survey in the manufacturing sector, conducted by the Institute for Supply Management on Monday, confirmed that backlogs fell by 2.1 percentage points compared to August. Inventory levels also rose, indicating an easing in supply chains. The Goldman Sachs Analyst Index also suggests that supply chain disruptions eased further in September. Fewer analysts are reporting their sectors are suffering from supply shortages and more are reporting rising inventories. All of this tells us that supply chain problems – a major source of inflation – are easing.

6. Companies fail to raise prices. September data shows that corporate sales are stuck there, but profit margins peaked in early June and declined slightly in mid-September. “Companies are finding it harder to pass on their rising costs, as illustrated by the recent weakness in profit margins,” says Yardeni Research’s Ed Yardeni. Meanwhile, tech companies are returning to their longstanding deflationary trajectories and putting downward pressure on prices again.

7. Labor market dynamics are improving. The Bureau of Labor Statistics on Tuesday reported over a million fewer job openings than expected for August, down from 11.2 million in July to 10 million. This was the largest one-month drop since April 2020. It suggests labor market pressures are easing, easing upward pressure on wages – half of the feared “wage price spiral”.

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Why this is important for stocks

“Just the perception that the Fed is done raising rates would be enough to mark the bottom of the bear market and lead to a sustained rally,” says Yardeni. Falling inflation will also boost consumer confidence and help stave off a deep recession if one does happen. We are already seeing this happening.

Bank of America’s consumer confidence indicator rose to a five-month high of 33.7% on September 25, from a low of 27.6% in early July. “Consumers are more optimistic about the economy as significantly lower gas prices have somewhat eased inflation concerns,” Bank of America said. The September consumer sentiment report from the University of Michigan hit the highest level since April.

Extremely negative buy signal

The market certainly seems primed for a good rally. Investors are extremely bearish, a bullish contrarian signal. Investors Intelligence’s bull-to-bear ratio recently came in at 0.61, an unusually declining reading. All values ​​below one historically indicate good entry points into equities.

The American Association of Individual Investors’ sentiment poll, released Sept. 29, showed that just 20% of respondents were bullish, compared to 60.8% who were bearish. That brings the bear-to-bull ratio to three, a high only three times since this survey began in July 2008, says John Stoltzfus, Oppenheimer’s chief investment strategist. “This suggests to us that the bearish sentiment is extreme,” he says.

Bank of America is still cautious on stocks, but many of the bank’s sentiment indicators are solid buy signals. Its proprietary bull and bear indicator is set at 0. This is maximally bearish, but maximally bullish in the contrarian sense. Bank of America also found that the fund managers it surveyed have 6.1% of their wealth in cash. Historically, the market is a buy when cash levels are at 5% or above.

Michael Brush is a columnist for MarketWatch. At the time of publication he was the owner of NKE. Brush proposed NKE in its stock newsletter Brush Up on Stocks. Follow him on Twitter @mbrushstocks.

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