Investment Quick Thoughts: Inflation, The Fed & A Double Stock Market Bottom

Summary

  • Inflation topped expectations in August, virtually guaranteeing another large interest rate hike by the Federal Reserve next week.
  • Stocks have reacted to the news by selling off and showing just how fragile the low volume rally was.
  • The put to call ratio is likely to flip back to put heavy from call heavy, which would just shows that chasers always chase.
  • Q1 of any year is typically the slowest quarter, the Fed knows that, so, expect the Fed to back off a bit in either November or I think more likely, December.
  • A double bottom has a high likelihood of occurring between late October and early December, so, I’ll target my put selling to November and December.

At the start of the year, I forecast a year that looked a lot like 2018. That is, I saw the following: 

  • A significant stock market correction to start the year.
  • A rebound rally.
  • Inflation not backing off until late in the year. 
  • Stocks correcting and having a double bottom or worse in Q4. 

Read the entire forecast here: 

My 2022 Futile Forecast: The Dollar, Stocks, REITs, Crypto, Inflation

What’s important to know is that what I am NOT predicting in the nature of a pundit. What I am doing is laying out the scenarios that are more likely to happen. There are 2nd, 3rd, 4th and unknown scenarios as well. 

By laying out the scenarios, we can be mentally prepared with a plan on how to respond to whatever happens. The article above were my “base cases” which have turned out to be pretty close this year. 

What’s Next From Inflation And The Fed

Right now, multiple indicators on inflation are falling. It is likely we see  September with lower inflation numbers than August. Will that be enough for the Fed on November 2nd to back off? Probably not much, but maybe a little. 

What is more likely is that the Fed backs off at the December meeting. The timing of the meeting a bit further into the month will allow them to have both October and November data. 

It is very likely that November data is softer as holiday sales are likely to be blowouts of built up inventory. Make sure to have your checkbook ready for gifts on Black Friday. 

In addition, as I’ve pointed out when I talk about “skip straight recessions,” the first quarter of the year is historically the weakest for GDP and the lowest inflation.

So, a lot of things are lining up for the Fed to back off in December. We could see: 

  • a three month run of declining inflation.
  • knowledge that Q1 is a weak quarter in the face of falling leading indicators.
  • potential for Russia and energy situation to resolve positively. 

Of course, Russia could make the energy picture even worse into winter in Europe. That is inflationary for Europe and actually stagflationary.

For the rest of the world though, Russia putting the energy screws to Europe is is deflationary due to the economic slowdown there we have already talked about.

The Fed could back off to help Europe by instigating the dollar to fall, and Euro to rise, so Europe can more afford energy over the winter. In fact, I think this is a very real likelihood that the U.S. uses currency prices to help support Europe and keep them from having a heating crisis in winter.

The Russia Wildcard

There is a huge wildcard with energy prices. Russia is losing in Ukraine and that is bad for Lil Vladdy. I think the odds of “good news” on the end of Putin’s leadership in Russia becomes more likely every day. I still predict he is out of power by the end of next year. 

When Putin is removed from power, that will likely be monumentally good for the global economy as Russia will likely come back to Europe with an apology and a promise for a better future. 

Yes, there is some possibility of another hardliner in Russia, but if that were the case, why get rid of Putin? Could we see another hardliner just use Putin’s failure in Ukraine to take power? Sure, see this article on right-wing fury in Russia from Foreign Policy: 

Russia right-wing nutjobs
Russia right-wing nutjobs (Foreign Policy)

If the right-wing nutjobs maintain power, there is a possibility things get worse. I don’t think that’s the most likely scenario though. 

I think moderates will prevail, like they seem to be doing in the U.S. There really seems to be a natural limit on nut-jobs, just like they naturally occur. 

Watch this interview with opposition leader Garry Kasparov from the Kyiv Post:

Exclusive Interview With Russian Opposition Leader Garry Kasparov

He’s been suggesting there is already a slow moving coup against the Putin and the right-wing. I think he is most likely right. If he is, that portends a more Gorbachev like relationship with the west. 

If Russia moves to the center, then the energy equation becomes more stable and that would be a major relief on inflation. 

A Stock Market Double Bottom

Without another energy shock, and that is what we simply don’t know, I think the stock market tests the June bottoms between late October and December. 

I also think that “the great divergence” scenario that I have discussed is still the most likely equity scenario. In short, here’s the winners and losers I see… 

Winners: 

  • Growth companies.
  • 4th Industrial Revolution stocks.
  • Industrial companies that use 4IR well.
  • Communications companies off of bottom and into consolidation.
  • Clean energy and decarbonization stocks.
  • DNA, RNA and protein based biotech.
  • Industrial real estate on supply chains moving to North America.
  • Certain resource stocks linked to 4IR and decarbonization.

Losers: 

  • No growth companies.
  • High debt companies dependent on cheap financing.
  • Consumer staples.
  • Industrial companies that do not use 4IR well.
  • Fossil fuels that don’t have carbon capture.

Middle of the barbell: 

  • Most real estate in a higher interest rate environment, with a lot of redevelopment capex coming and Boomers fading into retirement. 
  • Utilities.
  • Big pharma.
  • Financials.
  • Consumer discretionary (stock pickers delight, some big winners, many losers and most in between).

Coming Soon

I’ll be doing a mega updates next week for our Stocks Of The Week and Retirement Income Options. Read the recent Global Trends ETF reports and Plug & Play Stocks pieces. 

2 Comments

  1. That’s a very tactical perspective Kirk! I appreciate what you do bro!

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