Inflation, which was once considered a curse for the stock market, is now being seen as a friend to the ongoing rally. A year after reaching a four-decade high of 9.1% in June 2022, the consumer price index (CPI) has steadily declined due to the Federal Reserve’s efforts. Economists are predicting that the Labor Department’s upcoming CPI release will show a rise of just 3.1% last month, the smallest annual increase since March 2021.
The slowdown in inflation has provided support to the stock market rally by confirming the belief that the Fed’s fight against inflation is working. Market experts point out that inflation peaks have historically been followed by double-digit equity gains, a trend that has been observed since the 1950s.
Adam Sarhan, founder of 50 Park Investments, believes that the Fed is winning its battle against inflation. He suggests that as long as inflation remains under control and the Fed doesn’t change its stance on interest rates, this is a golden opportunity to invest in stocks. Sarhan operates under the assumption that the current market conditions signify the beginning of a new bull market.
Since hitting its lowest point in October, the S&P 500 Index has gained over 20%, with a 15% increase since the peak CPI data was released in July 2022. The tech-heavy Nasdaq 100 Index has also risen by 40% from its lows last year, driven in part by excitement surrounding advancements in artificial intelligence.
The main driving force behind the market’s surge is the hope that diminishing inflation pressures will allow the Fed to wind down its monetary policy campaign this year. The campaign has raised the Fed’s benchmark interest rate from near zero in early 2022 to its current range of 5%-5.25%.
As traders head into this week’s CPI release, they are eagerly awaiting insights into the central bank’s future course of action. Following last week’s indication of a slowdown in the labor market, the upcoming figures will set the stage for stocks leading up to the central bank’s rate decision later this month.
Despite the positive outlook surrounding the stock market, it is important to consider the risks that still exist. Wall Street strategists, for instance, have maintained a bearish view, expecting a downturn in equities during the second half of the year as growth slows. Additionally, stronger-than-expected wage growth for June may prompt the Fed to raise interest rates this month and potentially once more before the year ends. If inflation shows signs of remaining stubbornly high, it could put pressure on certain sectors, especially technology companies.
However, strategists at Wells Fargo Securities remain optimistic, citing the correlation between changes in consumer prices and a commonly used measure of the money supply known as M2. They highlight the contraction of M2 over the past year and believe it will continue to slow inflation by reducing demand in the economy. This, in turn, may support higher equity prices.
In conclusion, while inflation was initially viewed as a threat to the stock market, its recent decline has become a boon to the ongoing rally. The expectation of easing inflation pressures has bolstered investor confidence that the Fed’s fight against inflation is succeeding. However, it is crucial to acknowledge the potential risks and uncertainties that exist in the market, with the possibility of a downturn in the second half of the year. Traders will closely monitor the upcoming CPI release for insights into the central bank’s next moves, but overall, the stock market remains optimistic, driven by the prospect of reduced inflation and higher equity prices.
