Wednesday’s Consumer Price Index (“CPI”) announcement revealed that year-over-year inflation has now fallen to 3%. Reflect for a moment on how far we’ve come from the time when year-over-year CPI was at 9%, a figure which led many to assert that hyperinflation was inevitable and equity markets were doomed. Yet again, we see how scare tactics tied to irrational behavior come and go with each passing headline . Rest assured, in my opinion, there will be another concern looming just around the corner.
Although the markets responded positively to the news, some may question why this headline didn’t trigger an even greater rally. Shouldn’t investors rush to buy stocks now that inflation has returned to approximately its pre-COVID level? Regrettably, those who have been patiently waiting for a clear path may find themselves disappointed.
Historically, markets act as a discounting mechanism, often shifting well ahead of news flows. Therefore, when the news finally arrives, it can seem less impactful than one might expect. As I write this, the S&P 500 has risen by 0.7%, a respectable increase. Yet this headline is precisely why the S&P has already ascended 16% YTD. The market has anticipated that inflation would decline significantly and did so swiftly. Investors jumped on this insight, purchasing stocks at more appealing prices well ahead of this news.
Most people intuitively understand this dynamic, yet rarely apply it to market analysis.
Allow me to explain with an analogy.
I have a friend who is an avid Cincinnati Reds fan. He follows not only the main team but also their minor league affiliates, keeping a keen eye on rising stars. This passion also forms a bit of a side hustle for him.
A year ago, my friend began talking about a new player in the Reds’ farm system, Elly De La Cruz, who he believed to be extraordinarily promising. He accumulated Cruz’ minor league baseball cards at discounted prices, with the goal of selling them for a substantial profit once the player hit the big leagues and gained recognition.
Fast forward and De La Cruz is making a name for himself on the primary Reds’ roster. His value seems to be increasing daily.
This strategy doesn’t preclude further value increase, but for that to happen, De La Cruz must exceed even the current high expectations. At that point, the potential is endless. However, the easy money on the minor-league cards will have been made by then.
Entering this year, I remember noting the pervading sense of bearishness. Conversations with clients and colleagues were more negative than I could ever recall, and yet the market was improving every day. Now, with the CPI back down to 3%, we understand why the market has been behaving the way it has. This doesn’t necessarily signal the end of the run, but it suggests that the easy gains for 2023 may have already been made.
Going forward, we’ll have to see if earnings and growth can propel stocks even further while the Fed digests this new information and outlines a plan for future interest rates.
Fortunately, unlike bear market rebounds of the past, we have several promising business opportunities developing in areas such as Artificial Intelligence (“AI”), Electric Vehicle (“EV”), and infrastructure.
I’ll share more on this topic in a future update.
~ Until next time
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