The Battle Lines Are Drawn.

While the FBI searching Trump’s home at Mar-a-Lago and its aftermath might have been the biggest deal in the civilian media last week, it was a complete non-event as far as the financial markets were concerned. There was only ever going to be one story last week. Well, maybe one and a half. Data released on Wednesday showed that the Consumer Price Index (CPI) measure of retail inflation was unchanged in July after a 1.3% rise in June, as gasoline prices fell sharply, offsetting continued increases in food and shelter costs. The year-on-year increase was 8.5%, down from 9.1% in June. The Core number, which excludes volatile food and energy prices, also showed signs of softening - edging up just 0.3% in July and now up 5.9% from a year ago. All these came in lower than expected. The following day we learned that the less impactful but still important Producer Price Index (PPI) measure of wholesale inflation of manufacturing raw materials actually fell 0.5% in July after a 1.0% gain in June, and was up “only” 9.8% from a year ago, down sharply from the year-on-year rate of 11.3% the previous month and well below analyst expectations. While both of these releases reinforced the idea of peak inflation, Fed-speak from various regional Fed presidents which generally described the data as a “welcome sign” that“could lead to a slowing” in the pace of rate hikes (for example, half a percent in September, not three-quarters) also pointed to the possibility of peak Fed hawkishness maybe having been reached. As regular readers will remember me saying, a perception that we have reached peak inflation and peak Fed hawkishness are two of the major requirements for a sustainable market recovery. So the investor battle lines are drawn .. On one side are the bulls. In their perfect world: * there would be an accelerated decline in inflation, * a very moderate slowing of growth, * the Fed opening the door to a pause in interest rate hikes in 2022 and regional Presidents backing off hawkish statements * China either has a much-reduced level of COVID cases or backs away from its Zero-COVID policy, * some kind of de-escalation, a pause or a cease-fire in the Ukrainian conflict. This ultra-cheerful scenario could generate a very significant further jump in stock prices across the board, possibly in the indiscriminate and chaotic manner that technical analysts have been waiting for to complete that final transition from overall bearish back to bullish conditions. The S&P 500 has already recovered more than half of its January 4th to June 16th decline in less than two months. Futures market positioning now strongly favors the probability of “only” a half a percent interest rate rise at the next Fed meeting in September instead of the previously-favored three-quarters of a percent and there are even a few Optimist Ultras who think it could be less than that. Since bottoming at 10,646 on June 16th, the NASDAQ composite index has rallied 22.5% to close last week at 13,047, technically entering a new bull market (up over 20% from a recent low). While the new bull market designation is largely symbolic, it does bring to an end the longest bear market for the index since the dark days of 2008. Lined up against the bulls are the bears who warn of a scenario where: * inflation just flatlines or dribbles slightly lower rather than substantially declines, * growth falls at a faster rate than inflation creating stagflation (see my weekly review entitled “Fear The Stag” from way back in October last year). At SPX 4,280, stagflation is most definitely not priced into stocks in any way, * the Fed doubles down on its commitment to keep raising interest rates as much and as frequently as it needs to in order to defeat inflation and regional presidents are not afraid to publicly talk up this strategy, * China continues to have to impose lockdowns over scattered outbreaks and a still-robust Zero-COVID policy, * there is no sign of de-escalation, a pause or a cease-fire in the Ukrainian conflict. This much more gloomy scenario could potentially unmask the recent rally as simply a house of cards and in need of correction back down to mid-June lows or even below to reinvigorate any kind of justified sustainable Demand. They argue that, by virtue of shorter term interest rates being higher than longer term ones (the infamous “inverted yield curve”) the bond market is screaming that we are headed for an economic contraction that hasn’t even had a chance to start yet. The economy has not yet begun to really feel the impact of higher interest rates, they say, since these take time to filter through. Normally, the economy has years to absorb 3% of interest rate increases. By September, the Fed will likely have hiked 3 full percentage points in the space of six months. As for the new NASDAQ bull market, they argue that explosive rallies of 20%+ are actually more common in bear markets than in bull markets. From 2000 to 2002, for example, the NASDAQ had multiple upswings of more than 20% that were each followed by steep declines and renewed lows within months. It wasn’t until October 2002 that the index finally entered a bull market that lasted for a few years. A similar pattern was seen during the 2008-09 financial crisis. The NASDAQ gained 25% from November 2008 to January 2009, but then fell 23% from January to March that year before it hit its lowest point of the crisis on March 9th 2009. But first blood went to the bulls, traders were impressed with the inflation data and started pushing prices meaningfully higher, spurred on by the approving nods from the Fed regional presidents and a general lack of fresh worrying news out of China. The bull case is getting more traction at the moment, although that can certainly change. It unquestionably doesn’t hurt that it is the preferred scenario that investors emotionally want to happen. Financial markets are often depicted as being like cyborgs driven by streams of purely quantitative data running roughshod over investor hopes and dreams. But sometimes such emotional “tilts” can put a thumb on the scale and be the bulls’ secret weapon. OTHER NEWS: Biden-bound .. The Senate passed the Inflation Reduction Act of 2022 (see this week’s EXPLAINER: FINANCIAL TERM OF THE WEEK below), a climate and tax package which would raise more than $700 billion in government revenue partly driven by a 15% minimum tax on large corporations. It passed through the House on Friday and is now heading to Biden’s desk for the president’s signature. Broadly speaking, it’s deemed to probably be net slightly positive for the green energy space and net slightly negative for pharma, but generally markets don’t expect its passage to have much meaningful impact on stock prices in the near term. Not so fast .. Over 38% of U.S. adults say they are now reconsidering major milestones such as buying a house or a car because of inflation. More than half of respondents to the survey from TheBalance.com said that, while they had been considering buying a car, getting married, purchasing a home, having a child and/or other major milestones in the next twelve months, inflation has forced them to reconsider those choices. Buying a car topped the list as the #1 milestone to be delayed. The next most common major purchase to be delayed was a home purchase. Of those who were originally thinking of buying a house in the next year, 78% are now planning to delay the purchase or are reconsidering the idea altogether. Among those who were considering changing careers in the next year, 72% are now planning to delay taking such action or are completely reconsidering doing it at all. Slapping it on the plastic .. In a sign of the continuing toll from decades-high inflation, Americans loaded an extra $46 billion on their credit cards during Q2 2022 and their balances saw the sharpest increase in more than 20 years. Credit card debt grew 5.5% from Q1 to Q2 and 13% year-on-year. Overall, Americans added $312 billion in mortgage and non-mort… This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit simonbrady.substack.com