On the inflation front, nobody is going to jump up and down about an 8.5% y/y inflation print, or 5.9% y/y for core. But, it’s becoming increasingly evident that the worst might be behind us in terms of price momentum. Notably, the 1-month annualized change in core inflation registered at 3.8% in July, the coolest in 10 months. But it’s going to take some follow-up readings to really lock this shift in. For example, the 3-month change is still running at 6.8% a.r. (down a percentage point in the month), while the 6-month is at 6.3% a.r. (down slightly). And, of course, all of these readings are still a long way from the Fed’s target range. Where does that leave us?
The bear case for stocks: It’s still a long way back to near-target inflation for the Fed; the disinflation process will be slow even if we're past the peak; and we’re only going to get there with more tightening and some meaningful economic damage sustained. Indeed, the 2s10s yield curve steepened this week, but remained well inverted at around 42 bps by the end of the week. There’s also still technical resistance ahead, with the 200-day moving average hanging closely over the S&P 500.
The bull case for stocks: Periods where inflation has peaked and was falling back toward target from above have been some of the best on record for returns. We outlined that in more detail in a report published earlier this cycle, which can be found here. There’s also a lot of bearish sentiment to unwind, with recent readings from Investors’ Intelligence, AAII and Conference Board showing attitudes usually consistent with market lows. Anything that allows the Fed to back off from what's already priced into the market will be jet fuel for stocks.