Tuesday, July 5, 2022 05:52 AM
Source: Bloomberg, Elena Popina
Days after this year’s selloff began, Ned Davis Research scrapped its bullish outlook on US equities. After the worst start to a year in half a century, the firm is bringing it back.
- A recent pullback in commodity prices could bring inflation down and tame the Federal Reserve’s appetite to raise interest rates, said Tim Hayes, the firm’s chief investment strategist. He lifted the outlook on domestic US stocks to overweight from the equivalent of neutral. The bond market’s gauge of price pressures over the coming half decade, or the five-year breakeven rate, is hovering near the lowest level since October.
- “Commodity decline points to future inflation declines, consistent with receding inflation expectations,” Hayes said in a note to clients. If inflation “expectations continue to trend lower, with commodities correlating on the downside and inflation starting to follow, the Fed and other central banks will be able to slow or even stop their tightening initiatives.”
- After spiking to a multi-year high in early June, the Bloomberg Commodity Index has quickly shed 14% of its value as metals, energy and agricultural commodities pull back. That’s pushed energy from the best-performing S&P 500 sector in three of the five months through May to the worst in June. While helping somewhat ease anxiety over inflation, the pullback in commodity prices did little to harm the S&P 500 since energy stocks make up less than 5% of the index.
- To gauge just how much declining commodity prices could tame inflation, Ned Davis Research’s strategists plotted the Commodity Research Bureau’s Spot Raw Industrial Price Index, moved forward by a year, and ran a regression to project a year-over-year change in inflation in developed markets. The regression model indicates that the inflation rate in developed markets should decline toward 4.3% by next May.
Source: Ned Davis Research
- While some view easing commodity prices and moderating inflation expectations as a bullish sign, a case also could be made that the retreat signals growing recession concerns. But even in a glass-half-empty scenario, the implications for the stock market would be cyclical and not secular, Hayes said.
- Hayes’s view offers a bullish case for the stock market that just finished the third-worst January through June period on record amid a triple whammy of sticky inflation, recession risks and a threat to corporate profits. Futures on the S&P 500 are trading 1% lower premarket on Tuesday, driven by weakness in economically-sensitive names.
- The agenda for the holiday-shortened week is packed, with US factory orders and durable goods on Tuesday, ADP employment and initial jobless claims data on Thursday and non-farm payrolls Friday.