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Has Trend Change Finally Arrived?

It appears so. This week’s inflation data confirmed what the Fed and a number of strategists had anticipated. Lower prices for commodities, peak housing, and cheaper gas at the pump would eventually be reflected in the Headline CPI number. July’s number came in at 8.5%, down from June’s 9.1%. This didn’t come as a surprise to those analysts not on CNBC since Core CPI (Headline less food /energy) and wholesale (PPI) prices weakened for a second consecutive month. This week’s data hints of the economy having reached Peak Inflation. While it’s still a far cry from the Fed’s sub-3% objective, it’s a first step in the right direction.

The stock market greeted Wednesday’s news with a rally that marked a full retracement of the June decline that closed an abysmal second quarter. The NASDAQ is now more than 20% above its June low with the S&P 500 up more than 15%. That’s triggered a shift in the narrative surrounding a retest of the low of this bear market to one of questioning the legitimacy of this rally and whether an end to the bear market marks a beginning of a new bull market. We’ll leave that to those paid to lure viewers into the next commercial as they wildly speculate over the Fed’s next response to Trend Change. We’re just happy to speculate that we’ve seen the worst of inflation.

A few high-profile analysts/investors believe Jerome Powell will remain undeterred in his march toward a Fed Funds level that will kill consumer demand, eradicate inflation, and tip the economy into recession. Oh, we shouldn’t forget to mention they’re also predicting rate cuts in 2023 to take us out of that recession. Highly Unlikely. We see no signs of the Fed deviating from its data-dependent approach to enacting policy. Many of the more strategic (long-term) analysts we follow look for the Fed to possibly back away from the 75bps hikes of the past two meetings as the board awaits further evidence of inflation’s retreat.

Three meetings remain for the Fed this year. We’re among those expecting a tapering of rate increases as the effects of prior rate hikes filter into the economy through year-end. That would be welcomed by the market. However, investors are advised to temper their enthusiasm relating to Trend Change with attentiveness to the effects of the Fed’s actions on corporate earnings. So far, inflation and tighter monetary policy haven’t had a broad, significant effect. It takes time for higher input, labor, and financing costs to filter into margins and consumer prices. While the data may improve going forward, the latent effects of receding inflation and the policy response may have a deleterious effect on earnings for selected issues through the second half of ’22. While the bottom of this market cycle may have been established, we don’t believe we’ll be revisiting the highs of the prior bull market soon. Stay tuned.

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