The Week Behind 

A Cool CPI for October means a cool week of gains for the majors. As CPI hit the wire, the US2YR and US10YR each lost ~30bps: a massive move in the bond market. Equally impressive, the USD experienced its worst day in 7 years. In other words, both the bond and currency market endorsed what would be a momentous move for stocks as it appears the FED has finally landed a blow against their illusive opponent: inflation. On the week, the DOW added 4.15%, the S&P500 climbed 5.9%, and the left-for-dead NASDAQ rallied 8.1%.  

Highlights

• It appears as though Republicans will secure a majority in the House of Representatives resulting in congressional gridlock, which tends to be bullish for stocks.
• The US2YR and US10YR both fell to critical levels of support with Thursday’s CPI. If not for a closed bond market on Friday, courtesy of Veteran’s Day, it is possible they would have continued downward.
• The USD fell to a critical level of support on Thursday as well. It broke through that support level on Friday, ending the week in sell-off. 
• FTX is in the process of filing Chapter 11 Bankruptcy. While I weigh the probability of contagion as minimal, it is possible wealthy investors in FTX sell stock they own at a gain to write off against the capital loss in FTX.

CPI and the FED

October Headline came in at 7.7% versus 8.2% consensus. Core came in at 6.3% versus 6.5% consensus. Each was also lower MoM. Since the report, the market – both bond and stock – have been cheering. Rightfully so. Ignoring real-world implications, inflation is toxic for investments across asset classes. The two-day move to end the week was amazing, but let’s not get carried away. It is only one month’s data. Do not ask October CPI to be more than October CPI. The FED needs more. That being said, the magnitude of the drop and the underlying reasons for it provide some justification for incremental optimism. 

Coming out of the FOMC, even after the presser, my prediction for December was 50 bps. October CPI increases the probability of that outcome. A smaller-increase to the Funds Rate in mid-December would be an influential catalyst for a Santa Claus rally. That being said, the setup into December’s FOMC is messy. We’ll have CPI and the FOMC in the same week. Despite what anyone at the FED will tell you, I expect that print to have disproportionate pull in their decision. 

The Week Ahead

Last week, treasury yields and the dollar collapsed. As a result, growth outperformed value. Friday, HC and Staples, the YTD outperformers, declined as traders took profits to reallocate to areas of the market that will benefit the most from a continued move lower in yields and the dollar: technology and software, the YTD underperformers. Concisely, traders took profit from the DOW to buy the NASDAQ. While the “easy” money has probably already been made, until the narrative changes, expect this rotation to continue. When the FED is away, the animal spirits in the market come out to play. 

Even though it’s only two days new, it has been a great rally already. While there is still room to run, let’s talk about two events we need to watch:

1. S&P500’s 200d SMA: a level of both technical and fundamental resistance. Technically, the 200d SMA is where the last rally folded. Fundamentally, valuation becomes a headwind. 
2. On Wednesday, Retail Sales releases. A weak number indicates deflation in consumer goods, reinforcing the message sent by CPI, adding to the rally. A hot number may make people reevaluate how good CPI was.

Otherwise, we need to be privy to a potential shift in the narrative. Right now, we are cheering the decline in yields. We have yet to discuss the reasons for that decline. If consensus forms that yields are falling because the FED is succeeding in slowing growth, then the conversation surrounding downward earnings revisions will be revived. 

Personally, I am a believer in the leadership shift theory. Broadly speaking, I think healthcare, staples, and select financials will outperform in 2023. These companies are better insulated from those earning cuts. Consequently, I am actually taking the other side of this rotation. As my NASDAQ-esque stocks bleed up, I am raising funds to average into the DOW-esque names I predict will lead 2023.   

Gridlock and the FED

Historically, gridlock has been good for equities. In this case, with a Republican House of Representatives, it is unlikely Congress will successfully pass any additional stimulus. This more restrictive fiscal policy is better aligned with the FED’s contractionary monetary policy. While the FED does not often comment on fiscal policy, they are not oblivious to it. Stimulus speeds up the economy, which is contrary to the FED’s goal of slowing it. With fiscal (congress) and monetary (FED) policy better aligned, there is an argument to be made that the FED may be more comfortable acting less hawkish because they no longer need to overcompensate for congressional action. However, it is also worth noting the split congress increases the risk of a government shutdown or debt ceiling showdown. Both of which are real possibilities in the next two months; both of which are bearish.