Image source @Visual China
Text｜Understanding the economy, author｜Daixianfeng
Overview
I still insist on the framework I have talked about for a long time before, that is, the "opportunity window". I think the market is still in a "window period". This means that during this period, there is no clear new direction for the Federal Reserve , interest rates or the economy (regardless of recession or not).
In this macro environment, the market can take a step back from the previous state of intensive pricing of Fed policies and rebound from the oversold state. At this time, the previous intensive selling is enough to be a sufficient reason for the rebound - which is what I called a reversal before.
The recent "peak" inflation has stimulated the market, which is just a part of this larger framework.
I think there are four situations in the market that will reverse and fall again: A. A very high inflation data appeared in August. B. Some extremely negative economic data suggest that the economy is about to fall into recession. C. China's economic recession. D. The market rebounds to levels considered too high. The possibility of all four situations:
, but most of the probability of implementation is relatively low.
A) Inflation .
The inflation rate in the month will not be ridiculously high. The decline in oil and gas prices does not support higher inflation. Instead, inflation may indeed be peaking—the CPI fell in July, while the core CPI and core PCE peaked a few months ago, in February or March. Inflation expectations have been declining since April. B) Economic figures.
The labor market is still extremely strong now, with the unemployment rate further down to 3.5% in July. This means that extremely negative economic data is almost unlikely to appear in the future, even soft data, such as sentiment data.
C) China.
China's economy has slowed down for more than a year. Therefore, economic weakness is not new. What’s new is that after the policy shift, economic data has not improved marginally. Moreover, the policies introduced seem to be relatively restrained.
But the market is always forward-looking, and economic data is a lagging indicator. As long as the policy is supportive and gradually strengthens, the market will see through the lagging economic data and actively look to the future.
D) Market rebounds excessively/sentence.
market may not have rebounded "too much". Since the market began to rebound, there have been many skeptical views. The so-called "shoe shining boy" hasn't started to persuade me to invest in the stock market yet - they are actually quite pessimistic. The
D scenario is actually difficult to figure out because it is about emotions and technical aspects. Emotional and technical aspects can explain well what happened in the past, but they are not very good to "predict" the future - can you predict whether I will be happy or angry tomorrow based on my facial expression today?
tries to use emotions and techniques to predict the market, and to me it’s like trying to catch fish with bare hands in a rushing river. I guess this is theoretically possible, but it will be very difficult. But I think if you can manage to grow bear claws (or some sharp nails), you might be able to do it.
For scenario D, all I can say is that the market will rebound until it no longer rebounds. This may sound stupid, but it actually has its reasons behind it. Here I am not predicting a specific market downturn or the index peaks.
For other markets, commodity is actually pricing the possibility of recession. And the market's understanding of the possibility of a recession will affect interest rates. Therefore, commodities are also trading at interest rates, falling as interest rates fall.
The Federal Reserve, interest rates and recession probability are the driving forces driving all markets. The market now has no clear view of their future direction.
That is to say, to a certain extent, the market is now in an information vacuum stage.
Therefore, the stock market may still rise, as long as there is a reason for excessive selling before, it is enough. Commodities may continue to fluctuate, and the reason they previously rose too high is enough.
inflation may indeed be peaking
inflation may (just possibly) be peaking. Although there are still many sticky components that may continue to drive inflation upwards.
overall inflation rate (CPI year-on-year change) fell to 8.5%. It was 9.1% in June. PCE in the chart appears to be increasing year-on-year, but this is the June figure at 6.8%. The pruned inflation figure also rose to 6.9% in June. From this point of view, June is indeed a bad month. The Fed also raised interest rates by 75 basis points. core inflation data peaked a few months ago. Core CPI peaked at 6.5% in March, with a consistent 5.9% in June and July. Core PCE peaked at 5.4% in February and rose slightly to 4.8% in July.
Inflation expectations have been falling since April.
survey-based inflation is much higher. Michigan inflation expectations fell slightly to 5.2% in July.
based on the market inflation expectations are very low. The 5-year 5-year forward fell sharply from April to June, but rose again since July. Its overall level is still very low. 10 years of breakven follows a similar trajectory. The long-term chart of
shows more clearly that the CPI level has been rising sharply since 2020. In this way, CPI's monthly monthly increase also increased rapidly.
If the month-on-month change of price starts to slow down, the price level stops rising sharply, and inflation data will also slow down - this is the result of cardinality effect .
price trend may ease.
M2 has been falling, which may eventually lead to slowing price levels or inflation.
Commodities have been falling since June. Even if commodity prices remain at relatively high levels, their pressure on inflation may be eased as long as they stop rising sharply.
supply chain bottleneck is also easing. The supply chain tension index fell sharply in July.
Supply chain bottlenecks are the initial drivers of inflation. Any improvement in this regard will alleviate inflationary pressures.
China's economy seems to be related to the supply chain pressure index. Although the economic data is relatively negative, I think China's economy should be improving. My previous view that China's economy is at the bottom of the cycle remains unchanged.
Housing and labor are key parts of inflation, but both show signs of slowing down. They may not have long lasting.
market is priced at interest rates
interest rates are driving everything.
Inflation is easing, and the Fed is not very concerned by the market for the time being, so interest rates have been falling. Correspondingly, the stock market rose and the commodity fell.
S&P rose due to the decline in interest rates, which is a mirror relationship with what happened before, and S&P fell due to the rise in interest rates.
On the other hand, commodities fell due to the decline in interest rates.
These are basically the reversal topics I talked about last week.
Sometime in the future, interest rates will eventually rise again, and stocks and commodities may also reverse again.
