Clearly the bulls are in charge right now given a combination of inflation moderating while there is no obvious recession forming on the horizon. This has investors hopeful the Fed is ready to freeze rates at the Wednesday 6/14 meeting...and maybe lowering rates sooner than expected. As such the S&P 500 (SPY) has reached a new 52 week high.
This bullish narrative got a boost in the arm Tuesday morning with the better than expected release of the Consumer Price Index (CPI) now all the way down to 4% versus 4.9% last month. On top of that the month over month reading was a very moderate 0.1% increase. This trajectory raises hopes that we can reach the Fed’s 2% annual inflation target without creating a recession.
This news also has investors now predicting a 91% likelihood of no rate increase at the 6/14 Fed meeting. And with that Tuesday provided another day of advances for the stock market.
I admit this is all quite positive for the bullish case. Unfortunately, the average investor does not really understand inflation. And thus does not dig below the surface to understand the internals of what is happening now...and why...and what all that likely means for inflation down the road.
The reason this exploration is important is because Fed officials are academics that absolutely, positively WILL dig below to the surface to appreciate the full picture of inflation. It is this broader/deeper view that will inform their rate hike decisions.
So, with that backdrop let’s spend a little time digging into the Sticky-Price CPI tools created by the Atlanta Fed.
Let’s start with the 4% year over year CPI inflation rate that is nicely down from the 9.1% peak from June 2022 and directly points to things getting better in the months ahead. Now consider this chart that breaks CPI into 2 components: Flexible Inflation (black line) and Sticky Inflation (orange line):
Flexible inflation is plummeting and actually down -0.2% year over year. The problem that Fed officials will no doubt notice is that sticky (AKA not so quick to change inflation) is still up +6.1% on the year. Let’s now look at the 1 month picture to help with our final analysis:
The importance of this 1 month chart is that its shows the most recent trends that are most helpful in predicting the next inflation readings. Here we see how volatile the Flexible part can be month over month. Sometimes spiking...yet this month plummeting at a -4.5% annualized pace.
More importantly we see how persistent that Sticky Inflation has remained high. And that the month over month data shows that the annualized pace of Sticky Inflation is still too high at +4.1% per year. No doubt the +4.3% wage increase reading from earlier in June is a big part of this Sticky Inflation equation.
So yes, inflation is coming down. And yes, the headline readings for CPI give good cause for bullish cheer. Yet under the surface Sticky inflation is far too high when 2% inflation is the target. And that does make the Fed’s next moves more complex than the market is appreciating at this moment.
3 Possible Outcomes for the Stock Market After 6/14 Fed Meeting
As shared earlier the market is now predicting 91% likelihood for no rate hike this Wednesday. And then about 63% odds of another quarter point hike in July before a long pause. Given this backdrop, here is what I believe are the 3 most probable outcomes in order of likelihood along with associated trading plan.
#1 Buy the Rumor, Sell the News
The Fed does exactly what is expected. No rate hike with ambiguous language that bulls will read as a potential future pivot to more dovish policies. Whereas bears can still say that the Fed will keep rates too high for too long creating a future recession.
Since the market already ran ahead full steam into the announcement, then likely some profit taking ensues. This is quite like a well anticipated earnings beat where traders take their gains off the table after the positive report. (buy the rumor, sell the news).
The trading plan here is to expect a consolidation under 4,400 as investors await more clarity on the path forward. The more it seems that inflation is getting under control while no recession forms = green light to emerge into long term bull market which would lead to more Risk On investing. However, this could also devolve into the next most likely scenario...
#2 Surprisingly Hawkish Tone Begets Serious Correction
Consider that the Fed has complained about sticky inflation the entire time. The biggest culprit being wage inflation which will likely only moderate if the job market weakens. Putting those ideas together it is not crazy to think that the Fed wants to throw a fastball under the chin of investors to knock them off the plate and thus weaken the economy...and employment...to put out the flames of inflation once and for all.
Meaning a 25 basis point hike on Wednesday would be a shocking development given current expectations. However, it makes a LOT MORE sense than pausing now and then hiking again in July. That plan, which the average investor expects, makes very little sense IMHO.
This unexpected rate hike alone would lead to an immediate 3-5% correction...maybe more.
However, even if the Fed holds rates steady on 6/14, Powell could still give a stern reminder of their hawkish resolve at his 2:30pm ET press conference. This could be accomplished by reiterating key talking points from the past such as:
- More work to be done to get down to 2% inflation target
- Higher rates for longer
- No rate cuts til 2024 at the earliest
- Recession still in our base forecast
- Higher unemployment rate too
It won’t just be the words that are measured...but the tone. Will Powell be a caring parent that is gently pointing out the path forward that is everyone’s best interest. Or will he stand on more of a bully pulpit where he is getting tired of inventors NOT GETTING THE DAMN MEMO!
To be clear, this outcome is not ensuring a return to the bear market. It simply will remind bulls that they are too optimistic and stocks would likely retreat to a trading range between 4,000 and 4,200 awaiting more details on what lies ahead.
The trading plan is to take profits off the table on the most Risk On, growth oriented picks. Consider a more balanced portfolio with ample cash on the side. Or inverse ETFs in the mix as insurance against downside on your core holdings.
Also, the stocks you own should be more Risk Off (conservative industry selections like utilities, healthcare and consumer staples with large cap bias).
#3 New Bull Market Confirmed!!!
Here the Fed does start the dovish tilt that everyone has been hoping for. That they do see inflation coming under control faster than expected. That they will pause now, and MAY be able to start lowering rates sooner than previously stated. Even more bullish would be to say that because of this their base case believes they can now avoid recession.
Here we would see more and more bears throwing in the towel leading to an immediate FOMO rally. Likely new all time highs above 4,800 before the end of the year. And probably 100% gains over the next 4 years which is the typical outcome for a new bull market.
The trading plan is to go RISK ON!
Kind of the opposite of the previous section. More small caps for growth oriented companies. Also give the banks a good hard look as they will bounce back even faster from recent weakness.
Again, please remember I listed these 3 outcomes in descending order of probability. And so this is the least likely path, which I would put at about 5-10% chance of happening.
Putting It Altogether
The first 2 outcomes are the most likely. And both call for recent stock advances to at best pause...and at worst roll back 3-5% as investors await more evidence of future economic health.
If indeed the odds of recession grow, then the lower stock prices will go.
Conversely, the more that inflation keeps abating...the more likely the Fed can manage a soft landing without recession. That would be a green light for further stock advancement.
I will do my level best to keep you apprised of how things develop and the logical changes to our trading plan to stay on the right side of the action.
What To Do Next?
Discover my balanced portfolio approach for uncertain times.
It is perfectly constructed to help you participate in the current market environment while adjusting more bullish or bearish as necessary after the 6/14 Fed announcement.
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Wishing you a world of investment success!
Steve Reitmeister…but everyone calls me Reity (pronounced “Righty”)
CEO, StockNews.com and Editor, Reitmeister Total Return
SPY shares rose $0.29 (+0.07%) in after-hours trading Tuesday. Year-to-date, SPY has gained 14.62%, versus a % rise in the benchmark S&P 500 index during the same period.
About the Author: Steve Reitmeister
Steve is better known to the StockNews audience as “Reity”. Not only is he the CEO of the firm, but he also shares his 40 years of investment experience in the Reitmeister Total Return portfolio. Learn more about Reity’s background, along with links to his most recent articles and stock picks.
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