Let the Good Times Roll... For Now

The Weekend Edition is pulled from the daily Stansberry Digest.

August hasn't gotten off to a great start...

We've seen some volatility in the major indexes since the start of the month – although the recent slide in the major U.S. stock indexes softened some this week. The catalyst was the latest inflation report from Uncle Sam.

The consumer price index ("CPI") for July came out on Thursday... And for the second month in a row, the numbers beat Wall Street's expectations – meaning they showed the pace of inflation last month was less than anticipated.

(Now, before you write in to tell me that these government numbers are unbelievable... know I'm a skeptic as well. Still, enough folks with enough money in the publicly traded markets care about the data – so here we are.)

The latest CPI report showed prices accelerating at 0.2% for the month. That was in line with the consensus estimate... But the year-over-year CPI checked in at 3.2%, slightly below the 3.3% expectation. And core CPI – excluding food and energy – was 4.7%, the lowest since October 2021.

Those are still historically high numbers. But they continue a trend of decelerating inflation from a peak of around 9% in June 2022.

In particular, the 0.2% month-over-month rise in prices measured by the CPI is more in line with what had been "normal" over the past few decades... before the pandemic and government stimulus took inflation on a wild ride.

So, all in all, investors celebrated the news. Bonds, stocks, and precious metals were up, while the U.S. dollar was down.

Another "pause" might be coming...

I'm talking about a pause in the Federal Reserve's interest-rate hiking spree of the past year-plus.

Thanks to the latest monthly jobs report, we now know the unemployment rate just fell again... while inflation has slowed by more than the markets expected for the past two months.

Last month, Fed Chair Jerome Powell said the central bankers wanted to see inflation keep decelerating if they were to ease off the inflation "fight." We relayed his comments on July 26 in a Digest issue the same day...

We'll be looking at everything. And of course, we'll be looking to see whether the signal from June CPI is replicated, or the opposite of replicated, or somewhere in the middle.

We'll be looking at the growth data, the labor-market data very closely, of course, and making an overall judgment. It's the totality of the data, but with a particular focus on making progress on inflation...

It certainly seems like what's happening in the economy is what the Fed wants to see.

Wall Street's latest consensus view is that the Fed will likely keep its benchmark bank lending rate where it is – in a range of 5.25% to 5% – when it meets next month on September 19 and 20.

As of today, the string-pullers at the Fed have seen inflation easing – again, based on their own considerations, not how it might show up in your budget – for two straight months. One more CPI report, covering August, is due before their September meeting.

Plus, the core personal consumption expenditures ("PCE") index that the Fed says it weighs most heavily also dropped to 4.1% year-over-year growth in June. That follows three straight months of 4.6% increases.

And while the Fed folks won't say this out loud... they are also cautious – maybe even frightened – about raising rates too much.

My colleague Dan Ferris and I have had a laugh or two talking about CME Group's FedWatch Tool on recent episodes of the Stansberry Investor Hour podcast. As we've seen, its reported odds on rate hikes constantly change – sometimes wildly and quickly.

But it's good for tracking the leading view of bond traders with real money in the markets.

Today, this tool shows that federal-funds futures traders are putting a near-90% probability on the Fed pausing rate hikes again at its meeting next month. That's up from about 70% just a month ago, and 82% last week.

This means investors are thinking, once again, that the Fed is closer to the end of its rate-hike plans than to the start.

Throughout history, that has been good for stocks...

Back in a May 9 issue of DailyWealth, Brett Eversole analyzed why stocks soar when the Fed pauses. He wrote then...

The answer isn't what you might intuitively expect. But it's good news.

Over the past 40 years, stocks have a history of soaring after the Fed pauses rate hikes. And it means we could see the markets soar 20% over the next year.

Now, Brett published this piece on May 9, shortly after the Fed put its first "pause" on the table. Since then, the S&P 500 Index is up about 8%. Should we get another Fed pause, stocks could start another leg higher.

In my narrow central-bank analysis... as long as the Fed sees a reason to pause, but also leaves open the possibility of raising rates in the future, it means the central bank thinks the economy is still relatively healthy.

Inflation numbers are coming down and reported unemployment is low. But the economy isn't weak enough that the central bank thinks it needs to actually cut rates to goose growth.

And as Brett shared...

Buying when the Fed pauses rates is a smart bet. The table below shows what happened a year after each pause in the rate-hike cycle over the past four decades.

Take a look...

We've seen six other rate-hike cycles in the past 40 years. In five of those cases, stocks were dramatically higher a year later. And the average gain was an impressive 19.5%...

These numbers might not gel with your expectations. But the forward-looking nature of the stock market really does explain what's going on...

The stock market's forward-looking mechanism doesn't always do a perfect job. But most of the time, if folks are worried about something in the future, the market has already discounted prices based on that possibility.

That's why when the Fed pauses, stocks tend to soar. Even though the worst of the economic pain isn't over yet, it's already priced in... which puts a floor under expectations. That means stocks tend to move higher, and fast.

Enjoy the good times – for now...

On Thursday, the S&P 500 bounced right off its 50-day moving average – which means it's holding above its short-term trend. And about 63% of stocks in the benchmark U.S. index are trading above their 200-day moving average, or the long-term trend. Take a look...

In the meantime, the dollar – measured relative to other major world currencies – is still in a downtrend that began last fall. As we've described before, a weakening dollar benefits U.S. stocks and anything else priced in dollars...

The chart of the U.S. Dollar Index ("DXY") is almost a mirror image of the S&P 500. If the Fed's plans don't change materially, this strong inverse relationship could continue.

But also remember, the good times won't last forever...

The technical trends are bullish in the short term. But risks can always upend the status quo.

If inflation rebounds (which is very possible, with energy prices moving the way they are), that could move interest-rate expectations higher again, hurting stocks.

A dose of deflation in specific industries could also change the game. So could mounting job losses. A credit crisis is possibly ahead, too, as our colleague Mike DiBiase has warned. Any or all of those situations would likely push the Fed to cut rates to rescue the economy.

This is when you'll likely see the elusive Fed "pivot." And it might not be good for stocks...

In June, we reviewed the history of similar time periods. Specifically, we looked at times in which inflation was this high and the yield curve was this inverted (for this long) ahead of the Fed cutting rates.

It hasn't happened often... just twice in the past several decades. But stocks fell about 13% both times.

That kind of decline could be in the cards if an "official" recession shows up later this year or in 2024. That's not the worst pullback in recorded history, but it's notable.

So, for now, the good times are rolling... But don't stop looking ahead.

Good investing,

Corey McLaughlin

Editor's note: No stock boom lasts forever. But you don't need to take a lot of risk to profit from what's happening today... And you don't even have to lose sleep over the Fed's next move. Instead, you can "play it safe" and still position yourself for massive upside potential – in any kind of market.

Right now, our colleague Dan Ferris is sharing how this strategy could help you double your money or better in the months ahead... Click here for the details.