The stock market surged on Tuesday in response to new inflation data suggesting that the Federal Reserve may be nearing the end of its campaign of raising interest rates. However, investors are advised to exercise caution and not hastily follow the market’s rally. The Dow Jones Industrial Average soared by nearly 500 points following the release of the consumer price index (CPI) reading for October, which showed no growth compared to economists’ estimate of 0.1% month-on-month growth. Additionally, the core CPI, excluding food and energy prices, hit a two-year low.
Wall Street interpreted this data as a sign that inflation may be easing sufficiently for the central bank to halt its rate hikes. Consequently, the likelihood of the Fed not raising rates at its upcoming December meeting rose from 85.5% to 94.8%. Moreover, the probability of a rate cut by March 2024 jumped from 10.5% to 28.4%, as reported by the CME FedWatch Tool. It appears that interest rates have peaked and the economy is on track for a “soft landing,” barring any unforeseen rebound in inflation.
For long-term investors, the advice is to remain invested in stocks and maintain the current course, rather than succumbing to the temptation of making impulsive investment decisions. Lower current and anticipated future rates are favorable for higher valuation multiples and the present values of future free cash flows. This is particularly beneficial for economic sectors reliant on debt, such as financials, housing, and automotive industries. Lower rates stimulate increased borrowing and demand for debt-reliant purchases, resulting in amplified loan origination at banks. Furthermore, a peak in rates is expected to trigger a surge in M&A and IPO underwritings, presenting a significant opportunity for the investment banking industry.
Despite these positive indicators, disciplined investors should exercise caution as the market is currently overbought, according to the S&P 500 Short Range Oscillator. As a result, it is advisable to sell rather than buy at this time to maintain cash reserves for targeting stocks with stronger business fundamentals. Once the market experiences a reduction in speculative activity, strategic buying can be pursued.
Although the headline CPI stands at 3.2% and the core index at 4% for the 12-month period ending in October, this data trend is encouraging. Nonetheless, the shelter index is a critical metric for the Fed’s monetary policy, and its sustained moderation is a significant factor. This index, which makes up approximately 35% of headline CPI, is closely monitored due to its direct impact on Americans’ unavoidable expenses and overall spending power, given that the economy is consumption-based. Therefore, a decline in the shelter index could be the most noteworthy aspect of the positive inflation data released on Tuesday.
In conclusion, while the market is showing positive signs, investors are advised to proceed with caution and maintain a disciplined approach in their investment decisions. This approach will ensure that they are strategically positioned to capitalize on future opportunities in the market.
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