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How Bad Was Last Week for the Rally?

April 16, 2024

The S&P 500 dropped to a one-month low and experienced the strongest selling we’ve seen since the first two weeks of the year as inflation ran hot, markets abandoned the idea of a June rate cut, and the two ongoing geopolitical crises (Russia/Ukraine and Israel/Gaza) threatened to escalate.

Looking at the events of last week there were some clear negatives, and the market reaction was legitimate. First, CPI showed the decline in inflation, which had slowed to a crawl in recent months and was fully stalled, and that challenged the idea of falling inflation, which has been one of the keys to this rally. Second, rate cut expectations for June were dramatically reduced, and the first rate cut is now expected in September. That challenged the idea of looming rate cuts, which had also been one of the keys to this rally.

But were these events material negatives that should make us suspect of this rally? No, not at this point. The key impact of the stall in declining inflation and delayed rate cuts is that it shattered the unrealistically optimistic view/ valuation, but it did not change the medium-term outlook. Put in more regular terms, others and I have called this a “Teflon” market in that no bad news would “stick” and stop the rally.

Well, last week, the hot CPI delayed Fed rate cuts, and geopolitical tension “stuck,” and stocks dropped accordingly. But there’s a difference between not perfect and bad, and that’s the key takeaway from last week. Inflation has stopped falling (not perfect), but it isn’t rebounding (that would be very bad). The Fed won’t cut in June (not perfect), but the Fed isn’t thinking about hiking rates (that would be very bad).

The bottom line is that the market was priced for perfection at 5,200 in the S&P 500, but it was forcefully reminded this week that the environment was not perfect and that stocks were declining accordingly. And given that sentiment and positioning were extended on the bullish side of the ledger, a continued decline towards 5,000 shouldn’t shock anyone. Unless we see more bullish factors deteriorate (meaning growth underwhelms or AI enthusiasm begins to disappoint) or the Fed talks about hikes or inflation rebounds, then any decline towards (or through) 5,000 in the S&P 500 is likely an opportunity to add long exposure at more reasonable valuations.

The bottom line is that last week’s news was bad, but the four parts of this rally remain largely intact (solid growth, inflation declining, Fed cutting rates, and AI enthusiasm), and it’ll take further deterioration to challenge the validity of the rally (although again, a further pullback near term shouldn’t surprise anyone).

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