Prices Down, Stocks Up—Is This a Turning Point?

Please note: This update was prepared on Thursday, August 11, prior to the market’s close.

Signs that peak inflation may be past, coming on the heels of last week’s strong jobs report, have sparked a rebound on Wall Street. The tech-heavy NASDAQ Composite entered a bull market on Wednesday, up 20% from its June nadir, a technicality that has no real significance but that Wall Street statisticians love to trot out. The index remains more than 19% off its November 2021 high and is down 18% for 2022.

Other themes that caught our eye this week and why they matter:

• Yesterday’s consumer price index (CPI) reading suggests that inflation may finally be cooling. Easing inflation pressures could mean a less aggressive Federal Reserve—a possible boon for equity investors. More on this below.
• The Senate passed the landmark Inflation Reduction Act last weekend, and passage by the House of Representatives is expected in the coming days before the bill lands on the president’s desk. What might it mean for you? Read on.
• The Federal Reserve Bank of New York’s Survey of Consumer Expectations registered notable declines in short-, medium- and longer-term inflation expectations. This matters because inflation sentiment can be a self-fulfilling prophecy: If you expect higher prices, you ask for a higher wage. But as wages go up, company costs go up, which leads to higher prices. As you see higher prices, you ask for another raise and the cycle continues. So far, this cycle has not kicked into gear.
• With second-quarter earnings season nearly complete, companies that did better than expected saw their stock prices jump by larger amounts than usual, according to FactSet. One reason: Fewer companies are projecting a negative outlook compared to the past decade—those relatively rosy expectations have caught traders’ attention.

Rising Prices: A Breather or a Peak?

Stocks rallied on Wednesday after headline CPI data showed prices up 8.5% annually in July—down from 9.1% in June. Most of the relief came from falling gas and airfare prices.

But consumers didn’t get a full reprieve from higher costs in July. Gas prices fell but food prices maintained their upward ascent and rent rose at the fastest pace in over 30 years. While food and energy prices are notoriously volatile, shelter is often less so.

To take it a step further: The Federal Reserve Bank of Atlanta breaks goods and services down into two buckets: Flexible (goods and services where the prices change a lot) and sticky (where prices don’t change often). In July, flexible inflation declined, but sticky prices actually rose slightly.

We don’t think it’s time yet to declare victory over inflation. Even if the year-over-year number declined, plenty of prices still rose in July, and inflation is likely to remain above the Fed’s preferred target of 2% for some time.

With that, we expect the central bank to hike interest rates again at their September meeting. As it stands today, two out of three traders expect the Fed to hike the fed funds rate by 0.5%. The third is looking for the Fed to move the benchmark rate up by 0.75% again.

The So-Called Inflation Reduction Act

Manager of Financial Planning Andrew Busa:

When we were bracing for the American Families Plan proposal back in 2021, we had our eyes peeled for some sweeping reforms: Changes to ordinary and capital gains tax rates, limits on Roth conversions, new required minimum distribution (RMD) rules and some estate-planning techniques were in the congressional crosshairs. 

Perhaps those issues resurface in legislation down the road, but you won’t find them in this bill, now retitled the Inflation Reduction Act. However, there are a few high-level points to mention:

• Medicare Part D premium growth. The bill aims to limit the growth of Medicare Part D premiums to the tune of 6% per year over the next decade. It also allows the government to negotiate the prices for some high-cost drugs. While this could eventually change how we project Medicare expenses for clients, we aren’t making any adjustments just yet.
• Shorter wait times from Uncle Sam… The IRS is getting a shot in the arm, with a chunk of funding going towards taxpayer services. In theory, this could result in shorter wait times on their help lines. We’ll be checking in with our industrious tax team to see if that holds true.
• …But potentially more audits. IRS enforcement is also getting a boost in funding. The result could mean a large increase in the number of taxpayers audits. Audits have decreased over the last decade, so the aim of this provision is to bring them closer to historical levels. The IRS has pledged that this would not result in increased audits for households earning less than $400,000 per year and would instead focus on “…large corporate and global high-net-worth taxpayers.” 

As Senior Research Analyst Liz Laprade mentioned in Tuesday’s Adviser Takeaway video, investors should know that the Inflation Reduction Act brings good tidings for some industries (including electric vehicle and renewable energy companies) and headwinds for others (pharmaceutical firms and some large-cap companies). Check out her informative take at the link above.

Chart of the Week: Market Responses to Outstanding Months

Interim Chief Investment Officer Jeff DeMaso: 

Vanguard’s 500 Index fund (a proxy for the S&P 500 index, since you can’t invest directly in an index) gained 9.2% in July—the fund’s 13th best month since its 1976 inception.

Given that the S&P 500 fell more than 20% in the first half of the year, the market was probably “due” for a bounce. Now that we’ve gotten a nice rebound, investors may be wondering what’s next. Those who held cash on the sidelines may be worrying, “Have I missed out?” Others may wonder: Is an outsized month of gains an opportunity to sell? The short answer to both questions is no.

Here’s why I’m unequivocal on the topic: I identified the strongest months in the market since 500 Index’s inception and looked at how the fund fared over the year following each. On average, the index posted a 15% return following the best months compared to a 13% average return in all 12-month periods from 1976 on.

The takeaway is simple: A strong month in the market isn’t a good reason to avoid the market going forward.

Podcast: Cash Is Back—How Can You Make the Most of It?

Zero, or near enough. That’s how much you could expect to earn on your cash holdings for the last dozen years or so. But now, with interest rates on the rise, cash is making a bit of a comeback.

In this episode of The Adviser You Can Talk To Podcast, Chairman Dan Wiener is joined by Jeff DeMaso and Andrew Busa to discuss exactly how much you should be keeping in your personal cash reserve, what your options are for deploying it and what pitfalls to watch out for when it comes to I-Bonds.

Listen now to learn more!

Strategy Activity Update

Please see below for a summary of the trades we executed over the week through Thursday and our current tactical strategy allocations.

Dividend Income

Sell iShares U.S Home Construction ETF (ITB)

Buy SPDR S&P Transportation ETF (XTN)

AIQ Tactical Defensive Growth

Sell Cash

Buy iShares Core S&P 500 ETF (IVV)

AIQ Tactical Multi-Asset Income

No trades

AIQ Tactical High Income

No trades

Adviser in the Media

Portfolio Manager Adam Johnson appeared on Fox Business, where he expressed his excitement over the latest inflation read.

Chairman Dan Wiener and Interim Chief Investment Officer Jeff DeMaso also made the media rounds this week. Dan discussed actively managed fund outflows with Ignites, money market fund yields with Crane Data and factor investing trends with RIA Biz. Meanwhile, Jeff spoke to Ignites and Citywire about Vanguard’s manager shuffle on its Global Equity fund.

In this week’s Adviser Takeaways, Senior Research Analyst Liz Laprade examined the Inflation Reduction Act while Account Executive and Financial Planner Diana Linn discussed the future of Social Security.

Looking Ahead

Next week we’ll get a broad, informative sampling of data, including reads on housing (permits, housing starts, existing home sale and homebuilder sentiment), manufacturing, retail sales, jobless claims and leading economic indicators.

As always, please visit www.adviserinvestments.com for our timely and ongoing investment commentary. In the meantime, all of us at Adviser Investments wish you a safe, sound and prosperous investment future.

About Adviser Investments

Adviser is a full-service wealth management firm, offering investment management, financial and tax planning, managed individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trusts, institutions and foundations since 1994. Adviser Investments and its subsidiaries have over 5,000 clients across the country and over $8 billion in assets under management. Our portfolios encompass actively managed funds, ETFs, socially responsible investments and tactical asset allocation strategies, and we’re experts on Fidelity and Vanguard mutual funds. We take pride in being The Adviser You Can Talk To. To see a full list of our awards and recognitions, click here, and for more information, please visit www.adviserinvestments.com or call 800-492-6868.