Stocks have fallen so much in 2022 that a turn eventually happens, but I should ask:
- “What will get retail investors to buy stocks again?” Most investors will say the catalyst is when “earnings bottom.” I disagree
- I believe “the catalyst” is when inflation is convincingly headed toward 2%
- The high level of inflation drove the Fed and other central banks to full “hawk” mode. And while some might say wage inflation is the new goalpost, that is overlooking that the key is inflation convincingly heading towards 2%.
- The Fed said it wanted consistent progress, which they once termed three months of progress. Thus, a metric is when 3-month annualized core CPI and core PCE fall to ~2.5%. The last two months of Core CPI are below 0.20%, so only one more month of below 0.2% and 3M annualized will be there.
- Based on my forecasts, I expect Core CPI to be ~2% (3M annualized) by Dec 2022 (released 1/12/23) and Core PCE inflation by Dec 2022 as well. Core PCE for Nov/Dec PCE is 12/23 and 1/27, respectively. I believe 3M annualized core inflation is falling towards 2% before YE.
- I expect this to be positive for markets for two reasons.
- First, the Fed framework likely changes to “predictable Fed” as inflation is now operating near their long-term goal of 2%. I believe this would be a massive dovish pivot and could mean Fed pauses entirely in 2023 (maybe). This is true even if labor markets remain solid.
- Second, I expect equity and bond volatility to fall 20% or more. The VIX averaged >25 in 2022, and since inception, the VIX fell a median of 19.5% in the following year.
- By the way, the bond market has already sniffed this out. This is why I believe 2Y (4.212%) and 10Y (3.721%) yields are both well below Fed Funds currently (4.330%). And why 1-yr inflation breakevens are down to 1.89% (USGGBE01 Index on Bloomberg).