I said no to pizza this week. Shocking, I know. Why did I say no to pizza? It costs too much. Seriously, the place we like to get pizza from on Friday nights charges me $50 for two pizzas. Look, it is a really good pizza, but I just can’t justify paying $50 for two pizzas.
Inflation is always and everywhere a monetary phenomenon. It is also very psychological. Central bankers don’t fear inflation, they fear inflation becoming embedded. It’s not just about pizza. It’s about getting the house painted or replacing the windows. I am making adjustments and refusing to pay the higher prices. The economy is slowing as everyone is adjusting to the new inflation regime.
We had good news on the inflation front this week. Inflation is most likely peaking here for the time being. This is a multi-year fight. We told you weeks ago about how inflation is calculated and that OER (rent) is being mispriced and how that will bring the headline numbers down. The inflation bug will seem more in control if we have several consecutive lower readings. So far, we have one in a row. Helping the idea of a Federal Reserve pivot to lower rates will soon be unemployment readings. Those readings will begin to worsen, clearly showing the economic slide. The mid-terms are over, and the real readings can begin to come out. The numbers have been off for months. This is just what Washington, DC does. Not Democrats or Republicans – both.
The market is fighting the last fight. While there is relief on the inflation front, the economy is headed in the tank. Some aren’t borrowing. Some aren’t buying houses and furniture, and some are making changes to the brands they buy or choices they make. Either way, the market rallied because it believes inflation is coming down and the Federal Reserve is going to pivot towards lower rates. They skipped a step. The economy must stumble for the Fed to pivot. The economy stumbles. Then the market stumbles. Then the Fed pivots. I don’t think we get to skip steps here.
The rally this week was led by the lowest-quality and the most hated stocks of 2022. Not the signs of a lasting rally. The thing that will make this rally last is FOMO. Investors are afraid of being left behind and underperforming with a Santa Claus Rally on tap. We are comfortable in that we sidestepped most of the downside, and our core was tilted towards equal weight S&P 500 rather than market weight. That means we were not exposed to the tech sector and had an extra dollop of energy stocks.
Commercial real estate, residential real estate and leveraged loans are under pressure. The pivot is not to lower rates. It is simply to stop raising them. They may be higher for longer. The post-pandemic shift to headwinds rather than tailwinds is still in place, and we need to buy cheap. Valuations are still elevated singles and doubles. No home runs right now.
The G-20 conference is here and the US dollar has turned – just like we said. There is a lot to help stocks now. 4150-4200 is the target resistance on the S&P 500 for now, and we would take off risk again.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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