Hitting rock bottom usually isn’t something people look forward to. But for investors hungry for relief from the latest market selloff, rock bottom couldn’t come soon enough.
On Tuesday, the Dow Jones Industrial Average, Nasdaq Composite, and S&P 500 touched new 52-week lows. But the S&P 500 closed slightly higher while the Nasdaq gained nearly 1%, or 114 points.
Still, the tech-heavy Nasdaq traded is at its lowest level since November 2020. The Dow, which closed down 0.26%, or 85 points, has had six straight weeks of losses and the S&P 500 and Nasdaq experienced five straight weeks.
The market selloff comes as the Federal Reserve is aggressively playing offense against the highest level of inflation in 40 years. In doing so, the central bank recently raised interest rates by 50 basis points, the biggest hike in more than 20 years. That came in addition to the Fed’s 25 basis point hike in March, which was the first rate increase since 2018.
The saving grace for investors could come from Wednesday’s consumer price index (CPI) report if it shows that inflation has peaked, analysts said.
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When will inflation go down?
If the headline CPI is below March’s 40-year high of 8.5%, some people may think that means inflation has peaked, but analysts say, not so fast.
“You have to squint to see the evidence,” said Keith Lerner, co-chief investment officer at Truist.
Here’s why: the headline figure is a year-over-year figure, which means the pace of price increases is calculated using April 2021’s already above target 4.2%. This is the so-called base effect that can shrink the headline number this year.
“When you look at a 12-month trailing window, you’re lapping very high inflation in March, April, May, June of last year,” Federal Reserve Chairman Jerome Powell explained last March at a post-Fed meeting press conference. “So, there should be some effects from that in the 12-month picture.”
Instead, Powell says, it’s better to look at the month-over-month increases. In March, consumer prices jumped a seasonally adjusted 1.2% after gaining 0.8% in February.
But even the monthly figure can jump around a bit, some analysts noted. For example, energy prices eased after President Joe Biden said at the end of March the U.S. would release one million barrels of oil per day from its strategic reserves to ease high gas prices for consumers.
That decline will weigh on April’s inflation figure. However, prices have since climbed again. The national average for a gallon of unleaded gasoline rose on Tuesday to a record high of $4.37, not adjusted for inflation, according to AAA.
The breadth of price increases might be more telling.
“Inflation continues to be very broad,” said Michael Ashton, managing principal of Enduring Investments, LLC. “The price of everything is rising. The place to look is in the proportion of the consumption basket that is inflating rapidly, and that’s where my focus will be.”
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Ashton said he also will be particularly interested in rent prices, which make up more than a third of the overall index and about 40% of the core rate that excludes food and energy prices.
“There’s no sign that it has peaked or really caught up after the eviction moratorium ended or with the rise in home prices,” he said. “We know home price increases lag in the CPI by about 12-15 months so that says rent pressures will stay high for a while.”
Deutsche Bank expects rent growth to stay near current values for the rest of the year, with some risk of accelerating if the labor market tightens.
Will the Fed continue to raise interest rates?
Even if inflation slowed in April, it likely won’t be slow enough to veer the Fed from its aggressive rate hike cycle, economists said.
Data released after the Fed’s policy meeting last week showed unit labor costs surged 11.3% from a year ago in the first quarter, well above the overall pace of inflation and the fastest pace since 1982.
Fear of what economists call the wage-price spiral – or when an increase in wages leads to higher prices and then loops back again to push wages even higher to start the cycle again – is what the Fed is now focused on, economists said.
“Tight labor conditions are where the Fed seems to feel it can help shrink inflation,” wrote John Lynch, chief investment officer for Comerica Wealth Management, in a commentary. “The goal is to increase interest rates and thereby slow demand for labor in an effort to slow the pace of employment cost increases.”
When the Fed raises rates, it becomes more expensive to borrow money, which leaves people with fewer funds to invest. By taking such action, the Fed hopes to slow down the economy without causing a recession.
Diane Swonk, chief economist at Grant Thornton, estimates the unemployment rate must rise above 5% for inflation to cool to the Fed’s 2% target. On Friday, the Department of Labor said the jobless rate was unchanged at 3.6% in April.
If inflation levels out, the Fed eventually may be able to take its foot off the brakes. But one month’s read on inflation won’t be enough to convince the central bank to back off, Powell told reporters last week.
“We’d want to see evidence that inflation is moving in a direction that gives us more comfort,” he said, adding that the Fed would “just go back to 25 basis point increases” if inflation appears to be slowing as opposed to eliminating rate hikes.
As for Wednesday’s CPI report investors are looking for “any sign of softening CPI,” said Michael Reynolds, vice president of investment strategy at Glenmede. “That may tame some of the fears that the Fed really needs to tighten particularly hard in order to bring inflation under control.”
Will bond yields continue to rise?
If you’re looking for clues on when the market selloff will end, pay close attention to yields on 10-year Treasury notes, said Lerner of Truist.
Traditionally, 10-year notes are considered one of the safest investments. In times of heightened market uncertainty, investors tend to flock to bonds which sends yields lower and bond prices higher. Just the opposite is happening lately.
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Ten-year yields recently traded above 3%, the highest level since late 2018. This comes as the Fed is selling bonds as part of its effort to raise interest rates and investors are hesitant to hold onto bonds due to concerns about the Fed not having a good handle on inflation, Lerner said. But on Tuesday, yields dipped below 3% as investors bought more bonds.
That’s somewhat of a good sign for markets because it demonstrates that yields may be stabilizing as opposed to continuing to move higher, he said. “Stability in yields would suggest growing investor confidence that rate hikes are now being largely priced in and growing confidence that inflation is peaking.”
It also would help calm some of the stock market volatility since it is closely tied to moves in the bond market, Lerner said.
As for stocks, there are some signs that the market may have hit rock bottom.
In any given year, the S&P 500 has averaged a maximum intra-year pullback of 14%, according to Lerner’s analysis. That’s in line with the pullback the S&P 500 is currently experiencing from its high earlier this year.
But that’s not to say that markets can’t go even lower. Reynolds said we’re not at rock bottom yet and could have a way to go based on his assessment of current market conditions.
Should you buy stocks now?
“12 months from now, these prices will look very attractive,” said Tim Courtney, chief investment officer of Exencial Wealth Advisors. So it’s a good time to buy the dip, bearing in mind that it is impossible to perfectly time the markets to buy an asset at its lowest point, he said.
As for asset classes, Courtney is keeping an eye on small-cap stocks, or companies that are valued at less than $2 billion. “They’re undervalued,” he said. The S&P small-cap 600 index, an index comprised of 600 publicly traded small-cap stocks, is down more than 13% in the past year. While the S&P 500 index is down around 4.5%.
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Tech stocks, which have been getting clobbered during the selloff, also are attractive to buy right now, he added.
Meanwhile, Reynolds is telling clients to buy more short-term bonds while prices are still low and yields are high,
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This article originally appeared on USA TODAY: Stock market selloff puts focus on CPI data release. Is relief coming?