The market rally is heading into its 3rd month and is starting to show some teeth. From its June 16 low, the S&P 500 is now up roughly 16% and picking up steam. The pace accelerated over the last four weeks as the market began to sniff out a peak in inflation. Its suspicions were confirmed by a softer-than-expected inflation report for the month of July. Positive news on this front has led to a significant improvement in market breadth. Roughly 87% of companies in the S&P 500 are now trading above their 50-day moving average. We are getting much closer to conditions historically necessary for a bear-market bottom. 

Headline inflation came in at 8.5% for July. This was lower than economists’ estimates and marked a retreat from June’s multi-decade high of 9.1%. A sharp decline in gasoline prices was primarily responsible for the improvement. High prices are often the cure for high prices. Demand for gasoline moved lower over the summer months as drivers chose to stay closer to home. This is an important first step in taming inflation, but there is a long road ahead.

A peak in nominal inflation does not mean the end of inflation as an issue. 8.5% inflation is still far too high, and the Fed has a lot of work to do. It continues to raise the Fed Funds rate sharply at each meeting and has accelerated the pace of its balance sheet reduction. Still, the tightening efforts have yet to slow a red-hot labor market. The US economy added over 500,000 jobs in the month of July, and unemployment came in at a record low. Yet, employers are still struggling to find employees with the right skills. Wage pressure remains and continues to show up in higher service costs. We likely need to see the job market soften before we see inflation normalize. More tightening is necessary.

From the market perspective, however, softening inflation means that the Fed can tighten at a more reasonable pace. A soft landing is not out of the question. It is important to remember that consumers make up over 70% of the US economy, and anyone that wants a job has one. Despite the high prices, consumers remain in a strong position. Longer treasury yields are leveling out as recession odds ease, and inflation fears relax, and we anticipate that this allows for stocks to trade more on their own merits. On that front, many companies continue to deliver superb dividend growth. For the full year, we expect they will increase their dividend payments by more than 9% on average. These companies are building value that we can have confidence in. 

Thanks, 
Preston May, CBE®
Research Analyst