Pro Perspectives 5/10/23

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May 9, 2023
 
We had the April inflation report this morning.  The year-over-year price change came in just under 5%.
 
As you can see, this is the slowest rate-of-change in the headline inflation number since April of 2021. 
Most interesting, this number is going to fall off a cliff by June. 
 
Because of this …
The April number reported today was against the low base shown in this chart above.  By June, that base will rise dramatically.  Even if inflation runs at a hot rate of 1/2 percent per month, from now through June, the year-over-year June inflation number would be 3.4%.
 
If inflation were to be flat over the next two months, the year-over-year June inflation would be in the mid-2s (percent) — converging on the Fed’s target! 
 
This is precisely why the interest rate market was pricing out any chance of a June hike today.  And why the market is now looking for 75 basis points in cuts by year-end.
 
This scenario would align with the message the 2-year yield is sending …
As you can also see, the 2-year was trading at a technical inflection point today, going into this number — and resolved with a big move lower.
 
Let’s take a look at where this leaves the spread between the Fed Funds rate and the 2-year yield (i.e. the difference between where the Fed has set short-term rates, and the market’s judgement on where rates should be) …
The market is 118 basis points lower. 
 
The tightening cycle should be done.  With that, nothing has had more influence on stocks over the past sixteen months than inflation, and the fears over a draconian Fed response to it.
 
And with the end of tightening, we are left with this chart.
As we've discussed in my notes, stocks have broken above this big descending trendline that represents the bear market of last year – also above the 200-day moving average.  The next big technical level to watch is 4200.  That's only 1% away.  
 
Meanwhile, we're just coming to the end of Q1 earnings season, which was expected to be the worst quarter of the year for corporate America, with a recovery in earnings growth expected to come in the second half. 
 
But the Q1 reports have been full of positive surprises.  As of last Friday, 85% of companies had reported, with above average earnings beats (79%).  And the earnings contraction, at that point, was just 2.2%, versus expectations coming into the earnings season of 6.7%.
 
And this also comes as the institutional investment community is positioned in a very bearish stance (twenty-year extreme short positions from the leveraged futures traders, and global fund managers most bearish stocks, relative to bonds, since 2009).  As we've discussed, these are contrarian indicators.
 
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