The US inflation report released two days ago triggered a sharp move lower in the US equity markets. Also, the US dollar’s bullish trend resumed.
So aggressive was the selling that the S&P 500 index registered the biggest percentage drop in two years. It closed at the lows and, on the following day, did not bounce.
Sure enough, investors had all the reasons to sell stocks. The inflation report saw that while a peak may be in place, inflation remains stubbornly high.
This is a concern for stock market investors because of the huge gap between the YoY inflation, now at 8.3%, and the Fed funds rate of 2.5%. Historically, the past eight cycles saw the Fed hiking until the funds rate exceeds the inflation rate.
Hence, more hikes are underway, and so the stocks tanked.
But there is one thing investors should keep in mind: the forward-looking nature of the stock market.
Stocks tend to bottom much earlier in a business cycle
A business cycle is made out of boom and bust periods. In a recession, stocks act as a leading indicator because they tend to bottom some half a year earlier than the actual turning point in the economy.
Truth be said, the US is not in a recession.
However, much of this year’s drop in the equity markets was attributed to fears of an upcoming recession. Could it be that stocks bottomed and will rise with the ongoing strength in the US economy? Higher interest rates are not necessarily detrimental to the stock market if that is the case.
Inversed head and shoulders pattern paints a bullish picture
The technical picture reveals an inverse head and shoulders pattern on the daily chart. The index reacted at the neckline and now is at a key level.
Put simply, stocks remain bullish from a contrarian perspective as long as they hold above 3,600. The neckline, seen at 4,200 points, should act as a pivotal level.
Any advance above the pivotal level would likely trigger renewed strength.
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