If there is one key takeaway from the April CPI and PPI data it is that inflation has not peaked and prices are still rising. Our take on this is the FOMC has lost control of the economy and will be forced to act more aggressively than they’ve so far indicated. Does Jerome Powell say 75 basis points is off the table? We say ha, and bet they do 75 basis points in June or more. It’s still 34 days until the next meeting and there is a lot of data to come out between now and then, and it's not like the committee or its chief have been right about inflation for the last 13 months. If our read on the CEOs is correct, most businesses are still seeing upward price pressure, supply chain issues are still plaguing production and driving inflation, and price increases to offset inflation are still expected so inflation is still cooking.
The Market Is Cashing In On An Inflated Economy
The combined effects of secular trends, FOMC policy, the pandemic, pandemic stimulus, and pandemic-driven consumer spending inflated the stock market to record highs. This is most easily seen on the chart of monthly price action where you can see the S&P 500 (NYSE:SPY) bouncing from a key technical level. That level is a primary trend line put in place way back in 2009 that has been tested and retested many times over the years.
At the time, we called the bounce the strongest trend following signal our generation will ever see and we were right. Now, with the tailwinds of pandemic spending blown and gone, supply chain log jams still impeding production, and inflation running out of control that bubble is deflating and may burst. The market may not fall all the way down to the trend line but there is no reason why it won’t. With inflation running out of control and the FOMC under increasing pressure to fix it, we see the odds of a recession mounting.
As bad as inflation is for the market, it is the earnings outlook that will drive it lower. The Q1 season is better than expected but that is relative to the Marketbeat.com analyst's consensus. The S&P 500 has beaten that consensus by more than 2000 basis points on average over the past 4 quarters and only outperformed by a few hundred bps this quarter. Worse, the strength we are seeing is due primarily to windfall profits in the energy sector and the outlook for forward earnings is in decline. The consensus for Q2, Q3, and Q4 2022 have all moved lower over the past few weeks and at the lowest levels in two months on tightening margins within the index. S&P 500 margin is down 50 basis points YOY, if this trend continues the S&P 500 will have nowhere to go but lower.
The S&P 500 Crashes Through A Key Technical Level
The weekly chart of the S&P 500 is downright chilling from a bullish perspective. The bears pushed the index down to test support at the 4100-4200 level not once but 4 times and crashed through on the 4th attempt. This level brings a Head & Shoulders formation into play and if it is confirmed the index could easily fall down into the 3,400 range simply based on technical targets derived from the pattern itself. The worse news is that bulls who were supporting the market at 4,100 could become sellers and add downward pressure to the market.
In the very near term, we think the S&P 500 could fall down to the 3,700 level before a relief rally comes into play. At that time, we are expecting to see the index move up to retest the support-turned-to-resistance level at 4,100-4,200 and that will be a very critical turning point. If the index confirms resistance at this level and the Head & Shoulders reversal the 3,400 becomes a very real possibility. If, however, the market can regain 4,100-4,200 as support the S&P 500 will most likely move sideways within recent ranges until the next big news comes out.
