It Didn’t, or Doesn’t, Matter

Yesterday seemed like a relatively routine day in the stock market.  Sure, stocks closed lower, but the magnitude of the decline was quite modest relative to the macroeconomic backdrop that prevailed.  On a day when 10-year yields rose by 12 basis points and crude oil futures jumped by more than 6%, a downward move in SPX of 0.58% wasn’t a bad result. That loss was recovered in the pre-market before a higher-than-expected CPI print had us off to the races.

Certainly, market internals were hardly positive yesterday.  Declining stocks and losing sectors far outweighed advances as rate hike expectations rose after the morning’s PPI report. But the magnitude of the downward moves was ultimately modest, at least when compared to the stunning moves in key economic inputs.  After yesterday’s close, I spoke to a journalism class and was interviewed by a student who asked the logical question about why stocks had such a bad day.  I replied that the bigger story might be that stocks had a relatively normal day despite the underlying reasons for a far worse one.

That intuition proved true when I awoke to find that pre-market futures had essentially erased yesterday’s declines alongside only minor improvements in bond yields and oil prices. This was the “ratchet effect” in action, though in a different format than what we saw a few months ago.  At that time, government officials would offer hopeful rhetoric about peace talks, and stocks would rally in response to falling yields and oil futures.  Then, as the talks led to naught, yields and crude would resume their advances, but stocks would not give back their gains. Now we saw yields and oil soar, while stocks were relatively tame yesterday; today stocks soar, even as yields and oil give back only a fraction of yesterday’s jumps. 

Thus, the stock market’s direction was clear even before the 8:30 ET CPI release.  Unlike yesterday’s PPI, where economists needed to dig a bit below a seemingly better-than-expected core reading, today’s CPI report showed an unequivocally higher core.  That rose by 0.3% in August, above last month’s 0.2%, which was also economists’ consensus.  Expectations for a hike at next week’s FOMC meeting rose once again. Futures, as indicated by CME FedWatch, now show an 86% probability of a hike, up from 72% yesterday, and 61% on Wednesday.  Once again, traders on IBKR Prediction Markets are a bit more sanguine, with an 80% “Yes” showing currently.

Pre-market futures dipped by only a few points before traders decided that even that modest dip was another in a long series of buying opportunities.  Long yields initially dipped, indicating that traders perceived that the FOMC would embark upon its inflation fight more quickly than anticipated, though the quick 4-basis-point improvement in 10-year yields evaporated to only a single basis point by noon.  Once again, that move in bond yields was ignored by exuberant equity traders. 

An awful set of preliminary University of Michigan sentiment numbers was also duly ignored.  The headline sentiment number plunged to 47.8, above May’s record low of 44.8, but well below last month’s 51.7.  Meanwhile, 1-year inflation expectations rose to 4.6%, well above last month’s 4.0%.  Much of that latter gain was likely the result of higher gasoline prices, but the direction and magnitude of both moves do not bode well for the consumer – at least for those on the lower portion of the “K-shape.”

By the way, one rationale for this morning’s rally was that solid results from Oracle (ORCL) after yesterday’s close offered ratification for the copious spending on artificial intelligence.  That made a bit more sense when that stock opened 8% higher this morning, but far less so with ORCL trading lower at midday.

Call it what you will: nihilism, willful ignorance, or a legitimate hope that inflationary pressures will benefit the long-term economic picture that underlies stock valuations.  But the underlying message that we received over the past couple of days is that equity market psychology remains quite solid, if not unshakably so.  I’ll leave it to you to decide if that is proper or not.