The High Price of Lower Inflation!

What’s the true price of getting costs down? It’s a question that should be top-of-mind in the equities market, but the bears and short-sellers have been frustrated month after month as short-term investors continue to climb the wall of worry.

This is what can happen when the two prevailing sentiments on Wall Street are greed and denial. We witnessed this with the Peer Street Chapter 11 bankruptcy as a touted firm was doing hundreds of millions in loans but then came to a screeching halt, and here we are. It’s yet another sign of times that few among us choose to acknowledge.

It’s astounding to see how far the market can push stock prices with little regard for fundamentals. Earnings season is about to start, and corporate earnings are expected to decline for a third consecutive quarter. Specifically, the consensus estimate is for a Q2 year-over-year EPS decline of around 7% in S&P 500 companies, which would represent the sharpest decline since 2020.

Furthermore, S&P 500 companies are expected to show no year-over-year revenue growth for the first time in 10 quarters. These aren’t signs of a healthy economy, but A.I. hype has propelled large-cap stock indices – led by just a handful of tech giants, especially NVIDIA – in a rally with strong momentum but narrow participation.

It’s harder to discern the cracks in the foundation if Wall Street is busy massaging the numbers. The trick is akin to the old bait-and-switch: economists set a low bar that corporations can easily clear and then revise estimates higher after the fact, thereby artificially pumping stock prices even higher.

It’s a rinse-and-repeat trick that strategists can use again and again. There’s no shame in this game because Goldman Sachs and UBS have both acknowledged a “low bar” for earnings in Q2.

The upshot is a melt-up market, and you could end up as the proverbial frog in the pot of slowly boiling water if you stay in there too long. Just like the frog, you won’t notice that the temperature is rising until it’s too late and you’re already cooked.

Who’s at the stove gradually raising the temperature? Naturally, it’s the officials at the Federal Reserve who have been applying heat with 10 interest rate hikes during the past 11 FOMC meetings.

Sure, they “paused” at the most recent FOMC meeting, but that was more of a “skip” since Federal Reserve Chairman Jerome Powell strongly hinted at two more interest rate hikes before the year is over. Meanwhile, at least two Federal Reserve officials recently indicated that more rate hikes are needed in order to slow down inflation.

In particular, Cleveland Fed President Loretta Mester said she thinks that interest rates need to move up “somewhat further” and be held at that level. In addition, San Francisco Fed President Mary Daly echoed Powell’s idea that two more hikes will be needed this year to bring inflation down.

These central bank officials are clearly willing to pursue this headlong course of monetary policy tightening regardless of the damage they know it will do. For instance, even while Daly pushes for more interest rate raises (which will undoubtedly put pressure on banks and probably put more of them out of commission), she admits, “I don’t think we can declare there is no credit shock from the banking stresses. I think we still could see it coming in the next number of months.”

That’s the sound of an airline pilot telling the passengers that the plane is about to crash – or a slowly boiling pot where 99.9% of us are frogs since only a few controlling interests will benefit from the inevitable final meltdown.

All eyes are on the inflation rate, which is destined to decline since it’s a year-over-year comparison and June 2022 had the peak CPI print of 9.1%. Compared to that, inflation can only be so much hotter in June 2023.

Besides, Wall Street will always find ways to make the inflation rate appear lower than it really is on Main Street. This time around, the monthly CPI will be dragged down by the used car and truck component because used vehicles are apparently still fairly unaffordable, but that’s less than the prior reading of extremelyunaffordable.

Regardless of how they calculate it, economists expect inflation to slow down throughout the second half of the year, and that’s supposed to benefit everyone. At the same time, the nation’s central bank is taking extreme measures to achieve this, with the collateral damage including regional banks, borrowers (including practically anyone who uses a credit card, has a home or auto loan, etc.), small businesses, and countless others.

In other words, the Fed raising interest rates is crushing the economy more than people think, and certainly more than traders have priced into mega-cap stocks, but that’s been the plan all along since the elite bankers that control the stove are eager to boil the frogs but are smart enough to do it slowly.