Expectations Matter

Inflation numbers for July were released last week. We learned that consumer prices rose 8.5% from a year earlier, and the stock market evidently loved it! The S&P 500 closed Friday at the highest levels since early May.

Looking under the hood at the numbers, the food index increased 1.1%, which is the seventh consecutive monthly increase of 0.9% or more. Over the last 12 months, the food at home index rose 13.1%, the largest increase since 1979. Gasoline was 44% more expensive in July than it was a year ago. Airplane tickets are 28% more expensive. Across the board, your money gets much less now than it did one year ago. The stock market looked past inflation in the second half of 2021 when CPI was over 5%. But when Russia invaded Ukraine and commodities spiked, the stock market sold off in anticipation of higher inflation, higher interest rates, and a Federal Reserve that could slam the brakes on the economy.

Last week, for the first time since December, stocks were higher on the same day that inflation data was released. Why? Because expectations matter. If I have high expectations eating at a new restaurant and it turns out to be average, I’m always disappointed. If I have low expectations eating at a new restaurant and it’s decent, I’m pleasantly surprised. The same is true of the stock market. In the short term, the market is all about positioning and expectations. The stock market can sell off on great news if expectations are too high and it can rally on terrible news if expectations are too low. The market doesn’t always care about good or bad news, it cares about things getting better or worse.

Inflation is still at 8.5%, but it came in lower than expected. The yield curve is still inverted, but interest rates have actually fallen somewhat in the past two months or so. The Fed is still raising rates but it’s possible they will slow those rate hikes if inflation continues to fall. Gas prices are still high but they have been steadily falling for two months now. The year-over-year numbers are still high, but the month-over-month numbers are cooling rapidly. And if inflation peaked, and earnings were better than expected, and the labor market is still strong, then maybe the Federal Reserve doesn’t have to be as aggressive with raising rates going forward. Maybe, just maybe, they can slow inflation without causing a severe recession.

We’re not saying we’re out of the woods yet. The pace of improvement in the data probably needs to continue for the stock market improvement to continue. John Templeton said, “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” Maybe investor expectations had simply gotten too pessimistic recently.

Bottom Line: Sometimes all the market needs to see is that things aren’t as bad as originally feared. This doesn’t mean the current situation is good per se, but maybe things are better than they were two months ago.

As always, please feel free to reach out to me directly with any questions. Thank you for the continued opportunity to serve you.

- Brett