Will stocks continue to tumble?

After a string of sharp declines, the S&P 500 fell to near the 4,000 level last seen a year ago.

As I noted in my late April article, “The Big Drop, Again”:

On this view, the S&P 500, now at around 4,000, is basically an equilibrium price, depending on whether inflation figures released today by the US Bureau of Labor Statistics fall or rise – the current market expectation is for inflation to fall slightly from 8.5 per cent in March to around 8 per cent.

If inflation figures come in well above expectations again, above 8.5%, there could be one last drop.

If inflation comes in roughly as expected, around 8.0%, then stocks will rise on hopes that inflation will continue to fall, but by an uncertain amount;

If inflation comes in much lower than expected, at around 7.5 percent, there is a high probability that U.S. stocks will rally.

In other words, as long as CPI inflation is in line with expectations or below expectations, there is a high probability that stocks will rally.

As for inflation, in my article “Has Inflation Peaked I judge:

In other words, there is a high probability that US inflation has peaked in the short to medium term, although it is hard to say how much it will fall next.

Why do I call US inflation peaking?

First, the Fed’s monetary policy suggests inflation should be peaking.

In the article, “Can the Fed Control Inflation?” I specifically noted that the Fed controls inflation by the growth of the Currency in Circulation rather than by the interest rate, which is the traditional listing venue.

The reason is that the currency in circulation, or Chic, basically represents the amount of dollars society uses to buy real goods and services, so using the growth rate of dollars in circulation to control and manipulate U.S. inflation (excluding asset prices) are a handy tool.

The Fed’s idea for manipulating global inflation is simple:

Once it is found that inflation is soaring and climbing rapidly, it will try to reduce the growth rate of money in circulation.

If it sees inflation falling to 1% or less, it will print money and try to increase the growth rate of money in circulation.

The annualized growth rate of the Fed’s cash in circulation began to accelerate sharply in April 2020, peaked at 17% annualized growth in February 2021, and has since declined gradually. But from August 2020 to April 2021, the growth rate remained above 14%. It was not until after December 2021 that the growth rate of dollars in circulation fell below the normal 7 percent.

Taking all the delay factors into account, the peak of CPI inflation in the United States should have occurred between February and June of this year. That is to say, purely on the basis of the growth rate of cash in circulation, US inflation would have peaked in recent months.

The second argument for a possible peak in inflation comes from energy and commodity prices.

March’s inflation figures were greatly boosted by the price of oil, grain and many metals, which soared as a result of the Russia-Ukraine war that broke out in late February. We inflation data over the past 24 months also show that April 2021 is the turning point at which US inflation rises sharply from below 3% for many years to above 4%.

This also means that inflation in April 2021 is coming off a high base, and would only surprise on the upside if US prices continued to surge from March — which, as we all know, was just the month when month-on-month increases in global commodity prices moderated.

It is in this sense that my personal judgment is that the April CPI data is likely to moderate.

What’s more, why should stocks stop falling when inflation peaks?

Over the past month or so, the decline in the U.S. stock market is ultimately due to concerns that rampant inflation will bring the U.S. recession, which will lead to a decline in listed companies’ profits.

Higher inflation will also lead investors in U.S. stocks to demand higher returns from the stock market, either through higher corporate earnings or a lower stock market.

While overall corporate earnings beat expectations in the first quarter of 2022, many of the big tech companies that are the stalwarts of the U.S. stock market significantly missed estimates. The next path to boosting corporate earnings seemed a little difficult, they decided, so they had to sell tech stocks they thought were overvalued, triggering a continuing decline.

At the end of 2021, I wrote, “The U.S. Stock Market is on its Way.” The paper argues that the history of the U.S. stock market over the past 50-plus years shows that when real yields (the S&P 500’s yield — monthly inflation) hit deep negative territory, a deeper correction was inevitable, as in 1973, 1980, 2000 and 2008.

If the April CPI inflation figures moderate as expected or exceed expectations, it means that the negative real yields on US stocks caused by inflation will soon be moderated. Add to that the growth in corporate earnings, and stocks look attractive again.

According to Yardmen’s revenue and earnings per share forecasts for S&P 500 companies, published on May 8, earnings per share for S&P 500 companies could reach $240 in 2022 and $260 in 2023 — at the current S&P 500 level of 4,000, That equates to a PE valuation of less than 17 times and a forward PE valuation of around 15 times for 2023.

If the U.S. economy doesn’t fall into an immediate recession, stocks below 4,000 are, to some extent, pretty attractive.

 

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