Forget Lake Wobegon’s Our Lady of Perpetual Responsibility; this market is all about Immaculate Disinflation—but stocks will need more to keep rallying.
All three major indexes enjoyed another week of gains last week, putting the
S&P 500
up more than 17% through Friday’s close; the
Nasdaq’s
2023 rise is double that. Investors were heartened by various data points showing cooling inflation in the U.S. and abroad, even as jobless claims fell and earnings season kicked off with some wins. That furthered hopes that the Federal Reserve could back off its monetary tightening campaign before causing any major economic harm.
Bears have of course worried about the opposite: That ongoing high inflation would force the Fed to keep raising rates, pushing the economy toward a hard landing.
However, last week’s readings point toward falling inflation and stable economic growth—a goldilocks scenario, or Immaculate Disinflation, as Sevens Reports’ founder Tom Essaye writes.
Data confirming that inflation is slowing without hurting employment are undeniably good news, and has finally allowed some other stocks beyond a slim cohort of Big Tech to start enjoying the benefits of increasing bullishness. Yet as Essaye notes, last week’s reports “didn’t provide the market with a new positive catalyst, but instead just reinforced what was already widely assumed.”
Therefore, markets will need fresh bullish signals to extend their rally in what has already been a banner year for gains.
This could come in one of three forms, Essaye writes: Treasury yields falling sharply, stronger-than-expected earnings, or there’s a new round of artificial-intelligence optimism. Both falling Treasury yields and higher corporate earnings would allow the S&P 500’s multiple to expand further, leaving more room for the index to charge higher, while AI enthusiasm was the factor that pulled stocks out of their regional-bank-induced slump in March, and could therefore could lead the market higher even at rich valuations.
“Bottom line, at current levels, the S&P 500 has priced in: 1) No hard landing, 2) Falling inflation, and 3) A Fed that won’t be raising rates much longer (and possibly cutting soon after),” he concludes. “That’s basically the best outcome anyone could have hoped for at the start of the year, and that means the gains in stocks are legitimate, but also likely exhausted in the near term and it will take something else to push stocks materially higher from here.”
And despite a relatively benign environment, Essaye notes that investors shouldn’t let down their guard, as recessions typically appear only after the Fed ends rate hikes, and cooling inflation—while overall good news—could still weigh on corporate profits this quarter.
Still, assuming Goldilocks conditions reign, he argues that investors should be putting their money into cyclical sectors of the market that have so far lagged behind the broader market but should ultimately benefit from Immaculate Disinflation. He likes the
Industrial Select Sector SPDR
exchange-traded ETF (ticker: XLI), the
Materials Select Sector SPDR
ETF (XLB), the
Energy Select Sector SPDR
ETF (XLE) and the
Financial Select Sector SPDR
ETF (XLF).
Since that market gains have expanded beyond just Big Tech recently, these stragglers should be able to catch up, given the tailwinds behind them—and a wing and a prayer, which has carried so much of 2023’s rally.
Write to Teresa Rivas at [email protected]
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