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Markets Get Cold Feet Even as More Good News Rolls In

A trader on the floor of the New York Stock Exchange (NYSE) in New York, U.S., on Monday, June 27, 2022. Money managers betting on a sustained global rebound will be left sorely disappointed in the second half of this crushing year as a protracted bear market looms, even if inflation cools.
A trader on the floor of the New York Stock Exchange (NYSE) in New York, U.S., on Monday, June 27, 2022. Money managers betting on a sustained global rebound will be left sorely disappointed in the second half of this crushing year as a protracted bear market looms, even if inflation cools. (Bloomberg)

Everything’s Coming Up Roses

If you wanted evidence that the worst of inflation might be over, the last two days have offered quite a litany. Following Wednesday’s surprisingly quiescent consumer price inflation data (the headline index didn’t rise at all from June to July), Thursday brought more good news.

Producer prices have surged thanks to the oil market and supply chain snarl-ups. On the “finished goods” basis traditionally used, PPI in June reached its highest level since the first month of the oil embargo in 1973. On the “final demand” basis adopted as standard 10 years ago, it hit an all-time high earlier this year. Now, both measures have shown a sharp drop, while core PPI has also fallen on either basis, even though it doesn’t include the huge impact of higher oil: 

In the US, the American Automobile Association announced that the average price of unleaded gasoline at the pump had dropped below $4 per gallon for the first time since the Ukraine invasion, a relief to motorists and Democrats alike. 

On employment data, there are signs that the labor market is getting a little looser. The number of new claims for unemployment insurance remains very low, but the trend is clearly upward. Layoffs are running at their fastest rate of the year. Not great news in itself, this does buoy hopes that a weakening labor market will ease increasing pressure on wages and prices:

On the subject of the labor market, the Atlanta Fed’s wage growth tracker data for July, based on census figures and providing a good granular view of wage patterns, showed overall growth unchanged for the month at 6.8%. Pay rises for those in work actually dipped slightly, but the rewards for switching jobs continue to look great. Wage growth is at a high level, but any sign that it has stopped accelerating is positive in this environment:

The details also show that wage growth is following a remarkably equitable pattern. Wage-earners in the lowest quartile for earnings are enjoying average rises of more than 7%, the highest since the survey started in 1997. Those in the top quartile are enjoying growth of less than 4%:

All of the measures I’ve cited suggest a very “hot” economy, with high wage growth and still very high inflation in producer prices. The direction of travel at the margin, however, is always important in economics, and the fact that a number of measures have either fallen a bit or at least stopped rising is meaningful. Barring some big new external shock, like the Ukraine invasion or the Yom Kippur War, it seems reasonable to posit that the peak is in.

But it’s dangerous to go further than that. Economic logic takes a long time to work itself out in the real world. Markets are already looking forward to declines in interest rates as growth eases, because they are trying to discount future events — but this is all on the assumption that the Fed does what it says it will do, raise rates further, and leave them there for at least a matter of months. Unless it actually goes through with these actions, there is no reason to believe that inflation will come under control. And while it doesn’t want to crash the economy, the horrible example of the early 1970s, when the Fed under Arthur Burns correctly hiked aggressively as the oil spike hit, but crucially started easing before inflation had been totally beaten, will be on central bankers’ minds. Burns’s treatment in history has been arguably unfair, but it’s certainly been brutal. It’s not a fate that Jerome Powell or his colleagues will want to share. 

I commend the thoughts of TS Lombard’s chief US economist Steven Blitz, whom I will quote at length:

CPI appears to have begun decelerating, giving, to some, a sense that disinflation back to 2% is under way. It is not. This price deceleration simply reflects the unwinding of the Covid boom – reversing, for example, the price surge from reopening (hotels, airline tickets, rental car prices). First half GDP data similarly gave a false indication of recession when the data were only reflecting an unwind from the unsustainable real 6% growth pace set last year. Any current price deceleration runs in concert with the slowing of the economy from Covid to something closer to trend. In other words, any disinflationary trend from 9% is not signaling a shift in the economy’s fundamental supply/demand imbalance that is underpinning a base inflation rate below 9% but well above the Fed’s 2% target. The Atlanta Fed’s July sticky-price core CPI increased 5.2% m/m SAAR and is up 6.8% on a 3-month annualized basis. The NY Fed puts trend underlying CPI inflation in a 4.7% to 5.9% range. The economy is a long way from returning to 2% inflation.

Nobody’s saying that the latest data isn’t good, and it looks ever more as though the peak in inflation is in. But the analogy with a mountainous peak could be misleading. There is no analogy with gravity here, and prices won’t naturally fall without any effort to push them down on their way. Markets are currently positioned for inflation to fall because they are also positioned for rates to rise, and to stay high (by the standards of the last decade) for a while. Unless that kind of aggressive monetary policy actually happens, inflation is not going to return to anything like 2%. 

And for another indication that it’s not yet time to call the “all-clear,” take a look at how the market reacted.

Cold Feet

If Thursday’s news meant it was time to celebrate victory over inflation, then the market response should have been straightforward. Bond yields should fall, as the Fed would logically seem unlikely to keep rates either as high or as long as had been feared. Meanwhile, licking inflation, with the chance of a soft landing ahead, should have been great news for the stock market. As Points of Return pointed out yesterday, the S&P 500 started the day very close to retracing 50% of its decline since January. To close above that 50% retracement level would have been taken as a positive signal that the low was in.

And yet this is what happened:

Faced with the opportunity to take the stock and bond markets into territory that clearly reflected a belief that inflation had been beaten, investors balked. The S&P crossed the retracement line twice, and then fell back to end down for the day — a classic failed breakout. There will be plenty more opportunities to test resistance levels, and the market may not balk at the next one. But it’s very interesting that a raft of good news on the economy was treated as an opportunity to sell both bonds and stocks while they were still at good prices.

This isn’t just speaking with hindsight. Before the day started, Matt Maley, chief strategist at Miller Tabak, put out this note: 

The lower than consensus CPI number sparked another sharp rally in the stock market yesterday… and it took the S&P 500 index slightly above its early June highs. This is certainly a positive development, but we’re still going to have to see a bit more upside follow-through to confirm that this all-important index is indeed making a “higher high.” (As always, we have to guard against a head-fake… as slight breaks of resistance levels (and support levels) are never enough to confirm anything. We have just seen too many times when a slight break has reversed rather quickly… and the situation quickly reverses itself in a significant fashion.)

This does indeed look like it was another head-fake. And after all, even if the news is as good as it looks, that doesn’t mean that the Fed can relent. And with so much uncertainty lingering, any market recovery has to be clear-cut before it can be trusted. Victoria Fernandez, chief market strategist at Crossmark Global Investments, wrote this:

The Fed wants to continue to see financial conditions do the work for them, but deflationary reports are likely in the coming weeks. Financial conditions are looser now than they were when the Fed began the rate hike cycle back in March leading us to believe that the Fed is not inclined to put on the brakes yet.Have we reached a bottom then? We are not 100% in that camp. Bear market rallies and the start of new bull markets look similar but we need to see the broad-based momentum to believe this is more than a shorter-term rally.We have probably reached peak inflation, but the stickiness of the inflation that remains (i.e., rents) keeps pressure on the Fed and therefore the markets. We expected a summer rally due to better than expected earnings, but we aren’t satisfied that this is sustainable. A soft landing is still achievable, but we still anticipate volatility with so many unknowns out there.

There will be more tests for the market, and it may well pass the next one. Thursday’s message was that on mature reflection, the progress on the economy didn’t justify taking the stock market any higher than it was at the start of the day.

Insiders Are Buying

For the most revealing sentiment check on US equities, look no further than to corporate insider action. These investors have deep insight into the prospects for sales and earnings at their own companies, and when they move in tandem send clues to the broader market.

SentimenTrader looked at corporate insider buying and selling in the open market using data from Bloomberg dating back to 2010. It doesn’t count shares purchased as a function of exercising stock options granted by the company to an executive as compensation. Jay Kaeppel, the firm’s senior research analyst, acknowledges that the data don’t go back a long way and past results do not guarantee future returns.

All that said, the chart below counts how many insiders of S&P 500 companies have bought shares on the open market during the past six months. Insider buying, Kaeppel found, was good though not extreme. As expected, buying picked up — with a reading of nearly 400 — as the market declined. Currently, the indicator stands at 228.

“At least since 2010, readings of this level or higher (indicated in the chart with red dots) have been followed by higher stock prices 12 months later 98% of the time,” he said. “Generally speaking, a quick and dramatic pickup in buying tends to be an excellent sign for the stock market.”

While massive insider buying is seen as the most favorable signal, low insider selling can be viewed in the same light, too. The chart below shows weeks when an indicator of corporate insider sells crossed below 1,800. When the indicator was below this level, there were several stretches of weeks and even months that buying would have been timely and given hefty returns.

When insiders scoop up their own shares amid increased market volatility, it does look like a vote of confidence in their own growth outlook. It certainly can’t be used as any kind of precision-timing tool. But it’s worth following, particularly when the measures are married to create an insider buy/sell ratio. SentimenTrader found that the corporate insider buy/sell ratio crossed above 0.13 for the first time in four months. While this is nowhere near the height during the pandemic, previous times when the ratio reached this level all proved to be good times to buy: 

Kaeppel sums up what his indicator is suggesting as follows: 

Insiders tend to have a one-to-two-year time frame. However, when you see a period of insider accumulation... it tells you two things: 1) that insiders are anticipating improved fundamentals (higher sales and earnings), and 2) history suggests following their lead.

Professional investors might have a case of cold feet, but it’s meaningful that executives seem happy to put their money where their mouths are. 

—Isabelle Lee

Survival Tips

The word “nuclear” is trending on social media as I write (this report in the Washington Post is the unexpected reason why), days after the anniversaries of the atomic bombs falling on Hiroshima and Nagasaki in 1945. We can all hope that we won’t have to survive anything like that. 

To learn something less-known from this gloomy subject matter, I recommend the four episodes of the Revisionist History podcast in which Malcolm Gladwell went through the strategic and moral dilemmas that led to the fire-bombing of Tokyo. It’s fascinating. And you could listen to Enola Gay, the ironic and extremely melodic love song to the plane that dropped the bomb on Hiroshima, by OMD. It even found its way into the opening ceremony of the London Olympics. 

Have a good weekend, everyone.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

John Authers is a senior editor for markets and Bloomberg Opinion columnist. A former chief markets commentator and editor of the Lex column at the Financial Times, he is author of “The Fearful Rise of Markets.”

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