When there’s a big press release, I like to look at the market’s reaction before I see the numbers. I’m more interested in the reaction to the message than the message itself.*
A month ago, I drove into town with Josh and waited for the CPI report, my face glued to my phone. Futures collapsed at 8:30 am and I knew inflation was coming hotter than expected. Sure enough, the market wasn’t pleased to see core CPI rising at its fastest pace since 1982.
The Fed had hiked five rates up to that point, but this did nothing to slow inflation.
The Fed cannot fix supply chains. You can’t pump oil. You can’t make semiconductors. They have a tool to slow down the economy that didn’t seem to be working.
During that drive, all I could think about was how high interest rates would need to be to curb demand, and what kind of damage would that do to the stock market and, more importantly, the real economy?
Well, wouldn’t you know, on the day we got the worst inflation rate in 40 years, the S&P 500 was up 2.6%. But of course that is only half the truth.
In September, headline inflation rose by more than 8% for the seventh straight month. And as I mentioned earlier, the immediate market reaction wasn’t pretty. The S&P 500 was down 1.6% at open and continued its downtrend, falling as much as 2.4% at one point on the day, down 27% from its high earlier in the year. And then, for reasons no one can know, stocks went vertical. They gained 5% from the morning low and ended the day up 2.6%.
At The Compound and Friends this afternoon we talked about how fun it would be if the market bottomed out on the day we got the worst inflation news. We called this episode Good News is Bad News because markets are so weird sometimes. The thought was that maybe things were so bad that the Fed would slow the pace of rate hikes. Well that didn’t happen and it’s too early to explain that day the below, but the possibility is in play.
Yesterday inflation was 7.7%, which is not good in a vacuum. But markets don’t function in a vacuum. You move on expectations. Yesterday’s all-time high wasn’t as bad as we feared and the crowd went wild. The S&P 500 is up more than 5% for the 23rd time since 1950. I repeat, inflation was 7.7% and the stock market cheered like we just solved global hunger and world peace.
As you well know, when the markets are down, huge daily gains can only happen if the absolute worst doesn’t happen. The table below shows when you had these types of wins. You’ll see 1987, 2002, and much of 2008. When shares gained 5%, they were on average down 36%.
Stocks don’t do well or badly, they do better or worse than expected. And when expectations get too high or too low, it’s normal to see a violent reaction, like we did yesterday. It’s great to see stocks moving higher, not in hopes that the Fed will pivot because things are getting so bad, but because the data that had them moving so aggressively is actually showing signs of improvement. Good news is good news.
As far as inflation goes, we’re not out of the woods yet. It’s nice to see, but it’s only been a month. And the truth is, we’re never out of the woods. We’ll move from obsessing over inflation to worrying about why inflation is falling in the first place. Weaker demand will lead to lower spending, which will lead to lower profits, which in theory should lead to lower stock prices. Unless! Unless the market has already priced that in. And then it’s time to take care of something else.
*The first move is always the wrong move. Except when it’s not