The maximum inflation rate

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Stocks rebounded slightly after three days of intense selling pressure, while the 10-year Treasury yield fell back below 3%, boosting the tech sector. The yield peaked last week at 3.16%, which is very close to the 3.25% peak we saw in the fourth quarter of 2018 which caused the S&P 500 index to drop 19%. If long-term rates could stabilize at current levels, this would go a long way to supporting risky assets. Much will depend on whether today’s Consumer Price Index report shows that the peak inflation rate is behind us. That was my assertion last month with the print of 8.5% for March.

market averages

Finviz

This morning’s report is expected to show an increase of 0.3% for the month of April and an increase of 8.1% over the past year. The base rate, which excludes food and energy, is expected to rise 0.4% for the month and 6.3% for the year. Both would be declines from last month and suggest the peak rate is behind us. The inflation rate is still far too high for the Fed to moderate its monetary policy tightening plans, but if the investor consensus believes the rate of change is moving in the right direction, it could tip sentiment, stabilize long-term interest rates, and further bottoming out process for major market averages. This is my expectation.

inflation

Bloomberg

To see the rate of inflation come down this year, it will be essential to pull back commodity prices, which have had a torrid run this year following Russia’s invasion of Ukraine. Investment flows in the futures markets have fueled a massive rise in everything from crude oil to wheat to soybeans. Yet most major commodities peaked in March or April and prices began to stabilize.

Last month, I noted that the Invesco Commodity Index Track Fund (DBC) was trading 29% above its hugely extended 200-day moving average at $28.75. According to Dow Jones market data dating back to 2006, when the index goes well above its 200-day moving average, it drops 15% over the next three months and 41% over the next six months. Since the peak in April, it has fallen 6.5% and is now testing its 50-day moving average for the first time this year. If this basket follows its historical trend, it should continue to fall, as speculators take advantage of the huge rise that has taken place since the beginning of the year.

commodities fund

Stock charts

In my view, speculative investment flows have more to do with the direction of near-term commodity prices than with actual global supply and demand. The first time this came to light was in June 2008, when crude oil prices soared to $147 a barrel during what the consensus had yet to realize was a global recession. Prices can vary widely depending on what investors perceive of supply and demand in the future. I’m not saying we’re in a global recession or heading into one, but that commodity prices may drop significantly in the coming months based on a change in investor sentiment alone. .

Determining when this correction or bear market will end (depending on the index) is now hotly debated, and you know whose side I am on. There are compelling arguments on both sides, but I still think the majority of the damage has been done. It has long been said that major market declines start with the lowest quality and most speculative stocks, i.e. the soldiers on the front line, and end when investors finally eliminate the generals. If you look at the performance of the 10 largest generals in the S&P 500 year-to-date, they are down an average of 31.28%. Is it eligible?

30 largest SP500 companies

Tailored

If we’re in the early innings of a prolonged bear market that leads to a deep recession, then probably not. But if the valuation adjustments we’ve seen so far are simply a function of monetary policy normalization whereby real interest rates move back into positive territory, the Fed no longer prints money and the cost of capital no longer encourages galloping speculation, so that may be enough.

Today’s inflation report is essential. If this can persuade the investor consensus that the peak rate is behind us, we could start to see more stability in the stock and bond markets, as well as see consumer and investor sentiment improve from lows. historically low. This is my expectation.

Carol N. Valencia