What Just Happened?

Inflation and bond yields are thought by many to be the key to the stock market’s progress.  So how do we reconcile this morning’s lousy CPI report and rising bond yields with the mid-morning ramp in equity indices?

US equity futures were about 1% higher just ahead of the CPI report.  The enthusiasm likely stemmed from the UK, where we saw a sharp rise in gilt prices on reports that the Truss government would be reversing course on its tax program.  Fair enough – UK pension funds are a major source of concern for the global economy, and anything that reduces or eliminates their need to raise more collateral is a net positive.

But the reaction to overseas interest rates seemed excessive ahead of a potentially market moving US data release.  And no matter how we slice it, the CPI report was unpleasant.  Headline CPI was up 8.2% vs. an 8.1% consensus estimate, while core CPI rose 6.6% vs. a 6.5% consensus.  Even worse, the month-over-month numbers were even bigger misses.  Both were 0.2% above expectations, with monthly CPI rising by 0.4% and the monthly core rate rising by 0.6%.

Two months ago, we discussed why it is perhaps more appropriate to look at month-over-month changes price changes in the Consumer Price Index (CPI) rather than the more commonly reported annual change.  At the time, the July CPI report showed an 8.5% rise on a year-over-year basis, but a 0.0% month-over-month rise.  Our rationale was that “the year-over-year change in prices occurred almost exclusively in the 11 months from July 2021 to June 2022 since prices didn’t change in July 2022.” If we are trying to discern the current pace of inflation, it is more useful to focus on the newest data rather than blending it with 11 months of previously disclosed price changes.  This seemed to be wrong month for the markets to be shifting to a month-over-month view.

Futures plunged after the report, with ES shifting from a 1% gain to a 2% loss in a matter of minutes.  Fed Funds futures began to price in a near-certain 0.75% hike at next month’s FOMC meeting and greater than a 50% chance of a similar hike in December.  Rates rose across the yield curve, with 2-year yields rising 20bp before pulling back to a 15bp rise.  The 10-year yield showed much more dramatic rebound after its own 20bp rise; it is now up only 5bp.  That of course means that the 2-10 inversion is an even deeper 50 basis points, which indicates an even higher likelihood of recession.   That seems to be mattering little at the moment.

Even though we opened sharply lower, it became clear that there was little follow-through selling as the S&P 500 Index (SPX) flirted with the 3,500 level – a level not seen for nearly two years.  That was reasonable.  Traders don’t necessarily want to chase a down market lower, and while the inflation report was disappointing, it wasn’t necessarily bad enough for investors to ditch stocks at fresh lows. 

A trading truism is that if selling doesn’t work, try buying.  So, when selling was insufficient to take SPX through yet another round number, intrepid traders stepped in to buy.  When the selling abated and we began to bounce off the lows, others stepped in.  Then more joined in stocks began to reverse course.

Then, around 11AM EDT, we could see the unchanged level in sight.  And when the day’s loss was eliminated, a buying frenzy arose.  It’s hard to tell if the trigger was stop-losses or simply newly excited traders feared missing a new rally – or both – but we shot up another 2% in a matter of minutes.  And this where we find ourselves as I write this.

Traders want to gravitate to bullish narratives.  It’s human nature.  The last recurring bullish narrative was a Fed pivot, to which investors continued to cling despite repeated, strident statements to the contrary from a wide range of Fed officials.  In a recent podcast, I opined that “[if] the pivot were someone’s boyfriend or girlfriend, the pivot would be saying, ‘please lose my number, stop calling me.’” Thus with the pivot off the table, I’ve been hearing more frequent comments that markets often bottom in October. 

At a basic level, that is true.  Many of us have seen reports that investors can do better if they are invested from November through April rather than all year round.  That implies a bottom being formed prior to November.  But remember that this is anything other than a normal year.  Bear markets, like the one we’re in, don’t always follow that pattern.  I offer the examples of 2018, when we bottomed in December and 2008, when we bottomed in the following April.  Seasonality works most of the time, but is hardly foolproof.

If you’re buying into today’s rally because of intraday shift in liquidity, that seems sensible if you understand the risks.  If you’re buying because you’re afraid to miss a seasonal bottom, that seems a bit more dubious.  Just two weeks ago we cautioned that “FOMO is a terrible motivator.” Chasing markets that rise without an obvious catalyst can be a difficult errand.