Wholesale inflation comes in below forecasts … the 10-year Treasury yield is driving the bus … the S&P sits at a critical level … estimating the size of the potential move that’s coming for the S&P
The first of this week’s two key inflation reports came in relatively soft this morning.
The Producer Price Index (PPI), which measures wholesale inflation, rose just 0.2% in December. That was half of the 0.4% forecast. Core PPI, which excludes food and energy, came in flat.
On a year-over-year basis, PPI grew 3.3%. This was below the 3.5% forecast, but up from November’s 3.0% reading. Core year-over-year PPI also came in at 3.5%. That was below the 3.8% forecast but also hotter than November’s reading of 3.4%.
As I write mid-afternoon, the stock and bond markets are largely treading water in the wake of the data. All three major stock indexes are trading slightly higher, and the 10-year Treasury yield sits at 4.79%, same as yesterday.
For investors who have been concerned about inflation, this was a good report. So, why isn’t the market exploding higher?
Because the real question is what we’ll get with tomorrow’s Consumer Price Index (CPI) data. More on that in a moment.
Let’s step back to get a 30,000-foot view on what’s driving the market right now
When we do, one variable comes into high relief…
The 10-year Treasury yield.
For newer Digest readers, this is the single most important number for the global economy and investment markets. Interest rates and asset values worldwide are directly impacted by whether the 10-year Treasury yield rises or falls.
The higher it climbs, the more pressure it puts on most stock prices because a higher yield means a higher discount rate, which lowers the current valuation of a stock.
As we’ve detailed here in the Digest, the 10-year Treasury yield has climbed more than 100 basis points since the Fed began cutting interest rates in September. Much of that increase has come since reinflation fears began rattling the market in December.
Last Friday in his Innovation Investor Daily Notes, our hypergrowth expert Luke Lango connected the dots between the Fed, the 10-year Treasury yield, stocks, and his prediction for what was going to happen:
Before [last Friday], the financial markets were pricing in roughly two rate cuts in 2025. Now, they see just one rate cut this year – and they don’t see it happening until the third quarter of the year.
In response to markets repricing a Fed that will be on “pause” for several months, the 10-Year Treasury yield broke above major technical resistance at 4.7% and made a run for 4.8%. Real-time rates are now at their highest level in over a year.
This is the ultimate bane for stocks since valuations are rich and not supported by a 10-Year yield approaching 5%.
Either yields need to drop or stock valuations need to compress. Fortunately, we think the former will happen.
Yields are overextended. They’ll pullback. [This] week’s inflation reports should be the catalyst which ends this surge higher in yields. Then, stocks can resume their rally.
So far, Luke’s call for light inflation reports is spot-on. As we highlighted a moment ago, this morning’s PPI report came in soft.
But tomorrow’s CPI data will be the real needle-mover. And the likely impact on stocks in the near-term could be even more exaggerated because of where the market sits today…
As I write, the S&P finds itself directly on its 100-day moving average (MA)
To make sure we’re all on the same page, a moving average (MA) is a line on a price chart that shows the average price of an asset over some stated period. Moving averages provide investors and traders helpful perspective on market momentum.
These MA lines are important because they often trigger “buy” and “sell” decisions from the quantitative trading algorithms that drive so many professional portfolios these days.
So, if the S&P begins breaking either “up” or “down” from a key MA – like the 100-day MA – those quant programs are likely to emphasize the move as they join in the buying or selling.
Right now, the S&P sits directly on its 100-day MA. Below, we’ll look at this. We’ll also show you the S&P’s 50-day MA over the last two years.
What you’ll find is that during more bullish stretches, the 50-day MA (in red) served as a solid springboard for the S&P, bouncing it higher after brief declines.
But when the 50-day MA failed, the 100-day MA (in blue) generally came to the rescue.
We’ll discuss the times when the 100-day MA failed shortly. First, here’s the chart:
When we zoom in, you can see that we fell through the 50-day MA last week and are now sitting directly on 100-day MA (circled in blue).
So…
We will get the CPI tomorrow… which will impact views on inflation… which will drive the 10-year Treasury yield… which will drive the stock market… which now sits on the razor’s edge of its 100-day MA…
Bullish/bearish forecasts for what could be coming
If tomorrow’s data come in soft and we get a rally off the 100-day MA, we’d be looking for gains of somewhere in the 4% – 6% range over the next handful of weeks.
This broad forecast is based on how the S&P behaved after rallying off its 100-day MA over the last two years.
However, if tomorrow’s data disappoint and we break below the 100-day MA, how low might we go?
Here are the three times when the S&P fell 2% or more below its 100-day MA over the last two years:
- March 2023: the S&P bottomed about 2.1% below its 100-day MA
- September 2023: the S&P bottomed about 5.8% below its 100-day MA
- August 2024: the S&P bottomed about 2.3% below its 100-day MA
Not terrible.
Now, yes, falling an additional 2% to 6% below the 100-day MA would feel painful. Especially because those potential losses would be tacked onto the S&P’s 5% pullback since December. But historically, the garden variety pullback from here wouldn’t be awful.
However, all this goes out the window if a hotter-than-expected inflation print sends the 10-year Treasury yield skyrocketing to 5%.
In that case, we could be in for a more painful correction.
But even if that happens, let’s end with some historical perspective
A couple years ago, Schwab ran the numbers on stock pullbacks. From its report:
Market corrections are more common than you might think…
Occasional pullbacks have historically been followed by rebounds, according to the Schwab Center for Financial Research. Since 1974, the S&P 500 has risen an average of more than 8% one month after a market correction bottom and more than 24% one year later…
To illustrate the volatile nature of financial markets, we took a look at intra-year stock market declines over the 20-year period from 2002–2021.
As you can see in the chart below, a decline of at least 10% occurred in 10 out of 20 years, or 50% of the time, with an average pullback of 15%.
And in two additional years, the decline was just short of 10%.
Despite these pullbacks, however, stocks rose in most years, with positive returns in all but 3 years and an average gain of approximately 7%.
This supports Luke’s perspective on where stocks will go in 2025.
As we’ve detailed here in the Digest, Luke believes that we’ll enjoy our third consecutive year of 20%+ gains. But he’s quick to say that it’s likely to be bumpy.
From Luke:
This will be a good year for stocks. It will also be a very volatile year for stocks. Two steps forward. One step back.
That’s the dance markets will repeat all year long.
Buy on the one-step-back. Trim on the two-steps-forward.
We’re taking one step back right now. Soon enough, we’ll take two steps forward.
Until then, stay patient and don’t let the volatility get to you. It may be the new norm here in 2025. But so should continued strong gains.
Coming full circle…
We have one inflation report under the belt and it was soft.
It hasn’t sent stocks soaring, but neither has it sent them crashing. And that puts all eyes on tomorrow’s CPI report and the precarious position of the S&P, sitting on its 100-day MA.
We’ll keep you updated here in the Digest.
Have a good evening,
Jeff Remsburg
