Market Commentary: The Bulls Are Still in Charge

The Bulls Are Still in Charge

After consolidating some during the earlier part of July, stocks moved higher once again last week, with many stocks hitting new 52-week highs along the way. We are quite impressed to see cyclical areas like energy, industrials, and financials performing so well since early June. We heard time and time again that only a few stocks were going up the first half of this year, so to see things broadening out is a very good sign for the lasting power of this bull market. Additionally, those groups wouldn’t be leading if a recession was right around the corner like we keep hearing.

  • Stocks continued to move higher in the usually bullish month of July
  • Even after one of the best starts to a year ever for stocks, we continue to see many expecting rough times to come, potentially bullish from a contrarian point of view
  • Inflation has pulled back from 9% to 3% over the past year
  • Core inflation, ex food and energy, remains elevated, but looks poised to fall as vehicle prices and rental inflation ease further
  • The good news is that inflation has fallen without a recession, or rise in unemployment

Here’s the catch, the majority of investors are still doubting this bull market. Even though inflation has come back quickly (more on that below), wages growing faster than inflation, small business sentiment is improving, consumer sentiment is improving, housing bottoming, manufacturing bottoming, and a consumer that is incredibly resilient, there is still plenty of worry to go around. Again, we find this bullish from a contrarian point of view.

One of the reasons we expected higher prices this year was nearly everyone was saying they’d drop this time seven months ago. From a contrarian point of view, any good news could spark a big rally, exactly what has happened. Well, the more things change, the more they stay the same. Here’s a Bloomberg survey of strategists that shows this consistently bearish group is now the most bearish on the second half of the year ever. Don’t forget, it was this same group that was looking for negative returns in ’23 at the start of the year. Apparently, they are willing to double down and we aren’t sure that is so wise.

Take note the other years they expected lower prices during the final six months of the year were 1999, 2019, 2020, and 2021. All the S&P 500 did those years was gain 7.0%, 9.8%, 21.2%, and 10.9%, respectively, over the final six months. That comes out to a very impressive 12.2% average, not bad, not bad.

The Path to Lower Inflation Is Now Clear

The June CPI report was a positive surprise, both in terms of the headline numbers as well as the underlying details.

Headline inflation rose 0.2% in June, which translates to a 2.2% annual pace. Over the past three months, inflation’s averaged about 2.7%, and over the last year it’s up 3.0%. That’s well off the peak pace of over 9% exactly a year ago.

The reason for the decline is obvious when you look at the chart below. Energy prices drove the inflation surge in 2022, especially after Russia’s invasion of Ukraine. Energy prices have now declined 17% over the past year, pulling inflation lower. The good news is that food inflation is also easing a lot, rising at an annual pace of just 1.3% over the past 3 months. Remember the surge in egg prices? Well, egg prices have fallen 21% over the past 3 months.

All this of course has been occurring for a few months now and shouldn’t be a big surprise.

The problem until now was that “core inflation”, i.e., inflation once you strip out energy and food prices, remained elevated. But we got good news on that front.

Core inflation rose just 0.16% in June, which translates to a 1.9% annual pace – the slowest monthly pace since August 2021! That’s great, but the 3-month pace remains above 4%. So, we’re yet to see a consistent deceleration in core inflation, which is what the Federal Reserve is looking for.

Positive Signs for What May Be Coming

We realize that one month does not make a trend, but a lot of the underlying details point to downward momentum. Let’s look at a few of these.

Used and new vehicle prices, which make up 9% of the core inflation “basket”, have reversed a lot over the past year. However, used car prices rose in April and May, reversing some of that momentum. But things look to have turned around once again, with used car prices falling 0.5% in June. In fact, prices are likely to fall further over the next few months based on private used car auction data.

Moreover, the auto production supply chain bottlenecks are being resolved, and therefore we’re seeing vehicle production increase. As a result, prices for new vehicles have fallen about 0.4% over the past three months, and that downtrend is likely to continue given increased supply.

The big one is housing inflation. Housing makes up 40% of core inflation, but importantly, it does not include home prices. Instead, it’s based on rents. The problem is that there is a significant lag between official rental inflation and private rents data. Private data from Apartment List shows that rents have decelerated from a peak of 18% year-over-year pace to zero as of June! Official data lags this data by about 12 months or so and it’s taken a while to reflect market reality.

The good news is that official rental inflation is starting to turn lower. Rental inflation was averaging a 9% annual pace between June 2022 and February 2023. However, that’s fallen to about 6% over the past four months. That’s still higher than the 2018-2019 average of about 3-3.5%. But given what we’re seeing in market rents, expect housing inflation to continue decelerating and that’s going to pull core inflation down in a big way later this year and into 2024 as well.

What about the rest?

Fed Chair Powell has cited “core services ex housing” as still being elevated. This is their way of saying,

Yes, we see vehicle prices heading lower, and acknowledge the lags in housing inflation data; but we want to see the rest of it fall

But there’s good news on that front too.

The Atlanta Federal Reserve calculates something called the “Sticky Price CPI excluding food, energy, and shelter”. Simply put, it measures inflation for items whose prices typically don’t change frequently.

In June, this sticky price measure was flat. Over the past 3 months it’s running at a 1.4% annual pace, well below the peak of 7.3% we saw 15 months ago. A key piece of this is restaurant food prices, which have slowed down a lot recently on the back of falling food prices. But even things like airfares, daycare and pet care services inflation have been falling.

You can see why the June inflation report was positive from so many angles. A low reading is positive by itself, but it also confirmed what we know from other sources about what to expect going forward.

Perhaps the best news is that inflation is falling, and poised to fall even further, without a rise in unemployment and an economic slowdown. A year ago, Federal Reserve officials and many economists were saying that we probably need to go into a recession for inflation to slow down, and that aggressive rate hikes by the Fed would push us into one.

Instead, the unemployment rate is at 3.6%, close to 50-year lows. If real GDP growth clocks in around 2% for last quarter (as seems likely), that would mean the economy’s grown at a 2.5% pace over the past year. While inflation’s fallen from 9% to 3%. That’s huge!


This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.

S&P 500 – A capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The NASDAQ 100 Index is a stock index of the 100 largest companies by market capitalization traded on NASDAQ Stock Market. The NASDAQ 100 Index includes publicly-traded companies from most sectors in the global economy, the major exception being financial services.

A diversified portfolio does not assure a profit or protect against loss in a declining market.

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