Market Denial Gets Hammered Again

Stock investors, again, got schooled on inflation; and they came down hard, even with a big boost from Nvidia, which busted the $1,000-per-share level. While Nvidia took the Nasdaq and S&P 500 to intraday records, later economic data stripped all that fluff and falderal away and left all indices in the red with the Dow ending down 600 points. Yesterday was the Dow’s worst day this year.

"It maybe speaks to the fact that people are now positioned for disappointing growth data, slower inflation data, rate cuts, and this morning... it caught people wrong footed," said Brian Nick Senior Investment Strategist at The Macro Institute in New York.

What made the big turnaround?

Well, for starters that minuscule rise in new jobless claims and unemployment, which gave the market hope a week or so ago that the Fed would have to start cutting interest rates to avoid recession soon, all evaporated. As I suggested might fairly likely happen, the little blip upward in the unemployment rate just turned out to be another head fake. So, the Fed’s broken labor gauge is going to continue to hold it to tightening financial conditions for longer.

Not that it really is tightening. While its policy has remained steadfastly tight for almost a year, its loose words are always giving markets hopes and stirring animal spirits, which circulates more money in the economy, not less. Hence, business activity accelerated, which is not surprising, given how much Powell keeps undercutting his own tightening, almost as if by design. Manufacturing activity and services both picked up.

Said one commentator about the Market’s wavering sentiment,

“The worst thing would be for interest rates to continue going up at this point."

“The worst thing” is my base case. Rates will have to come up more to drive inflation down, and the longer Powell denies that, the worse inflation will be down the road, just as we saw him bring about when the present inflation began a couple of years ago. The market still has not prepared itself for “harder and longer” tightening. It keeps choosing to believe that won’t be necessary.

It will be. It’s already proving that month after month.

More than 400 names in the S&P 500 were lower, and information technology was the only positive sector for the day.

Treasury yields also rose as bond investors, too cowardly to be called “bond vigilantes” anymore, started pricing a longer wait on rate cuts back in. Stock investors also started giving way on their absurd hopes for a rate cut in September and started repricing that first cut toward November.

Traders are currently pricing just a 51% chance the Fed will cut rates in its September meeting, down from 58% a day ago and nearly 68% in the prior week, according to the CME FedWatch Tool. When the probability falls below 60%, it’s viewed as no longer likely that the Fed will take action.

I’ve been saying the market’s AI-based rally has no support because it is all contingent upon belief in falling inflation and Fed rates that are not going to come about as the market expects. Piper Sandler chief market technician Craig Johnson put it this way:

The market has “some loose footing…. This market’s strange mix of leadership, combined with breakdowns in transportation stocks and mediocre breadth readings, makes us not so confident that a new leg higher will be sustained from current levels.”

One of the forces that are powering inflation and that I’ve said will continue to do so for some time, which I’ve indicated the market is not taking seriously enough, is shipping due to the Houthi’s Red Sea war and blockage of the Suez Canal and the reduction in traffic through the Panama Canal due to extreme drought, making far less water flow than normal available. The inflationary impacts of all of that on shipping broke through in a more apparent way:

A perfect storm in global trade is creating a shipping container capacity crunch, fueling a sudden and surprise spike in ocean freight rates….

Ocean carriers are skipping ports or decreasing their time at port, and not picking up empty containers, in an effort to keep vessels on track for delivery.

The supply chain cost issues come at a time when consumer goods for back to school and the holidays are set to be moved on the water.

“From the Far East into the U.S. West Coast, it is likely spot rates will surpass the level seen at the height of the Red Sea crisis earlier this year, which demonstrates how dramatic the recent increases have been,” said Emily Stausbøll, senior shipping analyst at Xeneta….

Spot rates had fallen after the sharp rise triggered by Red Sea tensions in early 2024, but since the end of April they began spiking by as much as $1,500, on average, on routes to the U.S. coasts, and now some of the highest contract rates charged by shippers are over double the rates of just a month ago….

Stausbøll said this will bring back memories of the chaos caused by lack of available capacity during the Covid-19 pandemic. “Similarly to back then, some freight forwarders are now being pushed to premium rates to secure space guarantees,” she said.

(The article in the headlines below provides a lot more details on how complicated this is getting if you want them.)

Logistics price increases are ultimately passed onto the consumer and the dizzying freight rates during the pandemic were among factors cited by the Federal Reserve as a cause of inflation.

You’d think Powell & Friends would be paying more attention this time, but they hardly even mention it and continue to hope the present rise in inflation will prove to be a “bump.” Let’s just use the word “transitory” for them. They’re not listening to warnings like this that portray the force I’ve said we can suspect from the Red Sea and Panama troubles:

“Carriers are facing serious equipment shortage nowadays due to the long-term congestion, blank sailings, demand increase caused by South America tariff implementation and so on,” warned Orient Star Group in a note to clients. “Plenty of shipments are delayed by EQ [equipment] shortage which lead to heavy backlogs, and as a result, space shall get much tighter in the market. We’re trying our best to encourage the shippers to arrange empty container pick up as early as possible to occupy the resource well in advance.”

So, no to the fantasies of the marketeers who keep pushing for the mirage of a Fed pivot to materialize. No to those who stubbornly believe the Fed’s inflation fight is on its final leg down and the present rise was just a rest on the way. There are plenty of forces, as I laid out in last weekend’s Deeper Dive” that say inflation will continue to rise, especially with Powell not giving enough credence to these forces and continually loosening up the economy by giving the market the tidbits of hope that are all it needs to feed insane sentiment and rise again.

So that tiny dip in CPI last week that got markets so excited was, indeed, totally meaningless and misread as that Deeper Dive laid out.

Recently this put in a big “NO” to falling inflation hopes. That doesn’t mean the market won’t go right back to ignoring that with a “yes” of its own tomorrow. However, the punishment will continue until the markets fully capitulate. Reality has more staying power than fantasy or brute testosterone. The bull can ram his head against the bottom of the cliff all he wants, but eventually he’s going to kill himself. He can run off the cliff from the top, too, if he wants; but the cliff always wins. Reality is always tougher and eventually has to be faced.