Last Wednesday, we finally got a day where market futures were up. I was feeling good, hoping for a positive day.

Then the Consumer Price Index (CPI) came out.

Futures went sharply negative. The pre-open Nasdaq swung from +1% to -2%. The headline CPI number was terrible, rising 9.1%.

That was higher than expected – and higher than it’s been in nearly 40 years. This should come as no surprise, as we’re all getting pinched.

But under the surface, not everything is as bad as it seems.

So today, let’s take a look at what these new inflation numbers show… and project where we can expect the market to go in the coming months.

What Core Inflation Indicates

Inflation’s rise to 9.1% marks the quickest increase since November 1981.

Yet when we break down this 9.1%, we can see that the primary reason for this increase comes from two categories. In short, inflation lives in energy and food.

Removing those two categories leaves us with “core inflation.” And when we look there, inflation hit 5.9% when everyone was expecting 5.7%.

However, every month, core inflation has been falling. All items outside of food and gas have been coming down. In the last few months, core inflation has dropped from around a peak of 6.5% in March.

Eventually, the market digested the hidden good news on Wednesday, and the Nasdaq turned positive, similar to Thursday’s reversion.

People are starting to digest that there really is a light at the end of the tunnel. Inflation is actually moderating outside of higher prices in food and energy.

And there are even some optimistic signs in those two areas…

Food and Energy Are Starting to Calm

Everybody has been getting killed at the pump.

But over the last month, we’ve seen a little bit of relief. Prices have fallen from a peak of $5.11 to around $4.75:

That’s because oil prices peaked at just above $120 per barrel and have been slowly working their way down. That means lower prices at the pump.

Energy companies’ earnings lag, so their numbers will still no doubt be at record levels year over year. So energy companies are still a great inflation hedge for the time being.

As for food, “normal” prices are still hampered by the Ukraine conflict. Ukraine is a breadbasket country. In 2021, the country produced 10% of global wheat exports, and together with Russia, it supplies roughly 40% of Africa’s wheat needs.

The world has already begun to look elsewhere for food production, but it takes time to grow and harvest crops. Europe is also very environmentally conscious, and ESG initiatives for a more friendly environment clash with a supply reduction from Ukraine.

As a result, prices may be high for a while. Yet as supply chains continue to come back online, that should help mediate food inflation.

So as gross as the headline CPI number was, we can see indications that we are hitting peak inflation.

And there are additional signs of froth working its way out of the system…

Housing Prices Are Starting to Dip

As I discussed in a recent essay, housing prices have been insane over the past couple of years. Yet we’re beginning to see this turn around as well.

New mortgage applications are down, and rates have actually fallen for the first time in a long time.

Housing listings are staying on the market longer and even seeing price reductions. And inventory is finally starting to slowly grow closer to normal levels.

This was another area of CPI inflation that reported a wicked gain for July.

But with the initial signs of slowing in terms of housing and shelter, we should see improvement in this area in the coming months.

Where does that leave us right now?

A Choppy Summer Ahead

We’re in July, and summer months are typically choppy, as liquidity is low. Traders take vacations. And we are seeing additional illiquidity due to uncertainty over a recession.

Of course, even should we enter a technical recession (GDP contraction), many people have lost sight that we’ve experienced growth due to “free” and easy money flooding the system. One could argue the growth cycle we’re receding from shouldn’t have even been there in the first place.

If there is a recession, I believe it will be short-lived. The Fed does not want to shove the economy into a recession. Its hands are tied… It can’t raise rates too much with a $30 trillion national deficit.

Our 30-year average target rate is 3%, and right now, we’re sitting at 1.50%–1.75%. So while the Fed will likely take us up to the median 2.75%–3.00% range, we’re not looking at excessive increases from here.

Come Q4, we should have clear news of abating inflation. Energy prices will seasonally start to fall in September, easing consumer pressure.

Food production should start to adjust, while housing prices will abate. We should see also see even stronger labor figures by that point.

So while July and August will be choppy like normal summers, we should see more clarity from the Fed and economic certainty around September.

At that point, money should rush back into equities. There’s really no place else to put your money.

Even with higher rates, bonds can’t overcome a negative real rate of return net of inflation – certainly not at 9.1%!

Investing in stocks (especially dividend stocks with sales and earnings growth) is the oasis.

Finally, the euro is now at parity with the dollar. Europe is in poor shape with real recessionary pressures over there.

That means the U.S. equity market is the place to be. Many people fear we’re headed toward disaster, but I just don’t think that’s the case, folks.

And there’s one more signal I’m looking at right now…

The Big Money Index

One of our most powerful yet rare indicators is an oversold Big Money Index (BMI).

It gauges unusual institutional buying and selling over a 25-day moving average. Below the green line is oversold. Above the red line is overbought.

Here’s where we are now:

Some people may feel a bit of déjà vu. We’re almost oversold for the second time this year. That’s actually pretty rare. With May included, we’ve only gone oversold 21 times since 1990.

As a reminder, going oversold is good news.

On average, the forward returns we have to look forward to after we go oversold are strong:

  • One month: up 2.8%

  • Three months: up 6.3%

  • Six months: up 9.6%

  • Nine months: up 11.3%

  • One year: up 16%

  • Two years: up 29%

Of course, following the oversold signal at the end of May, markets only experienced a short-term bounce before reverting.

Yet if we follow the averages, we should have much better times to look forward to in the coming months.

So my advice? Ignore the summer volatility for now, and let’s keep our focus on Q4.

As inflation slowly abates and uncertainty eases, we should still be able to wrap up the rest of this year in much better shape.

Talk soon,

Jason Bodner
Editor, Outlier Insights

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