Friday's Market Minute: Extreme Bearishness Is Losing Momentum

The stock market broke down below a two-week trading range yesterday. Traders clearly made a statement about the prospects for inflation and overall economic health considering most recent economic data has been on the soft side. Weakness in both home purchases and refinance applications as well as the Atlanta Fed’s GDPNow real-time measure of inflation adjusted economic growth has been in a steady downtrend since the third week of May.

The last CPI report showed that April consumer prices rose 8.3% compared to last year vs. the 8.1% consensus, and today’s number needs to demonstrate a break from the high inflation trend for equities to stay above the mid May lows for the remainder of the year. Slowing economic momentum might have investors thinking that inflation will cool soon, and the Fed will back off before tightening policy to the point of recession. That would be good for risk assets. The most likely outcome is inflation will moderate, but there is a risk the Federal Reserve nudges the economy into recession. 

Many of the factors that have added to volatility this year are old news at this point and the market is in a bottoming process and beginning to look forward. The S&P is still down about 16 percent in 2022 but keep in mind that many of the factors responsible for volatility between record inflation, climbing interest rates, a more hawkish Fed, and even the Russia-Ukraine crisis are now antiquated headlines.

Even with all the headlines about how terrible everything is, most companies are still making money and are expected to generate growth this year. Extreme bearishness generally means the correction has been played out and signs of inflation peaking can allow for flexibility in Fed policy with better-than-expected macro data supporting a sustained move higher in stocks going forward.

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