Love is in the is inflation. Why are bulls not getting the message, asks Steve Reitmeister of Reitmeister Total Return.

Truly my brain hurts trying to rationalize the elevated level of stocks after two straight strikes against a bull market. What are those strikes? And is the third strike on the way Thursday?

Market Commentary

Let’s wind the clock back to Wednesday, February first. That is when the Fed announces yet another rate hike followed by an extended press conference by Chairman Powell. Every word he says is bearish to people who were already bearish. Shockingly every word he says is also bullish to folks that were already bullish.

The bulls won that showdown with stocks sprinting up near 4,200...the highest levels since the summer rally topped out at 4,300. Just two days later comes strike one against the bulls. That being a much stronger than expected Government Employment situation report showing robust job gains. That sounds great on the surface until you realize it came hand in hand with very persistent wage inflation.

This was precisely what Chairman Powell warned about that previous Wednesday and why the Fed will keep rates higher for longer than the market appreciates. Bulls scoffed at the notion the first time around. However, they did get taken aback when faced with that sticky inflation once more on Friday.

Powell then made it clear the following Tuesday, February seventh, at the Economic Forum that this employment report makes him believe that they may need to push rates higher...or keep them in place for longer to get inflation back to the 2% target. This extended hawkishness is a big strike one against the bulls.

Then came a bout of amnesia. Bulls just needed to buy something. So they got on the offensive once again on Monday with stocks up over 1% on the session. This seemed to be short-lived as strike two was pitched this Tuesday. I am referring to the higher-than-expected Consumer Price Index (CPI) report coming in at +6.4% vs. 6.2% expectations. This is obviously a far cry from the 2% target of the Fed.

What’s even worse is that month-over-month inflation was +0.5% which is 6% annualized. This flies in the face of those that say inflation really just happened in early to mid-2022 and that is what shows up in the year-over-year numbers. Sadly, this far too high month-over-month tally confirms the Feds' notion that the long-term battle with inflation is far from over.

The immediate reaction to this news was stocks falling nearly 1% early on the Tuesday session. Yet amazingly bulls fought back once again to a nearly breakeven finish. These bulls continue to see positive things that I am not...perhaps they are smoking things I am not as well.

Strike three may very well be on the way this Thursday 2/16. That is when the forward-looking Producer Price Index (PPI) index is announced at 8:30 am ET. Once again, the month-over-month reading should be the most telling as it speaks to what is happening in the here and now.

The forecast calls for only a +0.2% price increase, which is pretty tame. However, if we get served up something much hotter like Tuesday’s CPI report, then I suspect bulls will whiff on this third strike against premature bullishness. Let me overly simplify the bear case at this time.

The Fed will keep rates high through the end of the year given the facts in hand. Plus there are typically 6-12 months of lagged effects from Fed policy. This creates a window to create a recession that extends well into 2024.

When you add that to the notion that we already have many economic readings pointing to a weak economy at this time, then you have a recipe for the recession which begets lower corporate earnings...which begets lower stock prices. I previously stated that I would likely get more bearish with any subsequent break below the 200-day moving average (3,944). That is because it would be a confirmation that the rest of the market was finally abandoning its faulty bullish view of things.

However, I am tempted to make a move before that break if strike three is thrown on Thursday. This would mean adding more inverse ETFs to profit from likely subsequent market downside if inflation is still too hot prompting ever-vigilant hawkishness from the Fed. Remember that a return to the bear market means likely touching the previous low of 3,491 set in October. Or perhaps making it down to 3,180 which amounts to a 34% decline from the highs (which is the average decline for a bear market). Or perhaps even lower.

This is not to say that the bulls have no leg to stand on. Unfortunately, strike by strike in February it is becoming all the more likely they need to head back to the dugout and let the bears get back up to bat.

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