US stock market bulls experienced a month of respite as major indices have rebounded from their mid-June lows over the following five weeks. The Dow Jones Industrial Average crossed above 31,800 on July 19th after finding support upon dipping below 30,000 in June, and the S&P 500 likewise nearly hit the 4000 level on July 20th after having touched 3650 in June. Even with mixed earnings reports and a surprise 50 basis point rate hike from the European Central Bank seemingly prompting US stocks to take a tumble intraday on Thursday, July 21, investors were treated to another ultimately positive day as indices closed higher. However, despite over a month’s worth of restored buying pressure, this recent indices-wide leap is likely not as optimistic as it seems. Let’s explore fundamentals as we discuss why the stock market rally is a mirage, as well as what investors could expect timeline-wise.
USD Trade Complications
Although a soaring USD in the foreign exchange market enables American consumers to indulge in lower priced imported goods, the flip side is that it comes at a cost for many US businesses. For those corporations that have historically sold goods and services internationally, these prices overseas are now far higher than in years past, limiting foreign demand. Thus, a highly valued USD makes US exports (approximately 13% of US GDP) less enticing for trade partners, which can substantially limit revenue for these businesses in the US, disincentivizing potential investors by theoretically limiting their earnings and share prices. Considering that USD looks primed to continue its bullish trajectory into the near future, this could be bad news for US indices overall, and by extension GDP growth as well.
Ill-Fated Consumer Demand
As is the case in every market or mixed economy, corporate earnings in the US are predicated on demand for the products and services that companies are selling. High inflation is happening in America because, as in much of the world, demand for products and services has significantly outpaced their supply; this has resulted in today’s uncomfortably high prices and a hot labor market, bolstering corporate profits to a degree.
However, this strong demand is quite unlikely to remain. Factors such as US employees’ wages and salaries failing to rise at the rate of inflation (with average hourly earnings having increased only 5.1% over the past 12 months, compared to 9.1% inflation), as well as a hawkish Federal Reserve intent on aggressively cooling the economy through raising interest rates, will impair consumer spending. This will mean less income for US businesses by extension, as well as far less money spent buying stocks speculatively as in recent years.
Global Economic Conditions
Although the US economy is currently the largest economy in the world in terms of its $25 trillion GDP and vast net wealth, much of this growth has been due to its relationship with the global economy. By relying heavily on free trade agreements, as well as foreign direct and portfolio investment, markets in the US have been transformed by globalized supply chains and reinforced by an ongoing influx of new capital.
While this approach to prosperity ostensibly comes with benefits, such as cheap imported goods and huge financing possibilities, it also comes with liabilities, such as those we are encountering today. Globalized supply chains aren’t conducive to flourishing if the world’s economies are in a tailspin while supply is unusually limited. Likewise, US businesses can’t rely on buying pressure from foreign investors if these investors have less capital to work with themselves. Thus, the US stock market is in double jeopardy, as it must endure both global and domestic economic hardships.
No More Deus Ex Machina Fed
The Federal Reserve, the central bank for the United States, has established a unique role for itself over the past fifteen years as the lender of last resort. During the financial crisis of 2008, as well as the pandemic-induced crash in 2020, the Federal Reserve undertook unprecedented measures to save the US economy through monetary stimulus. By implementing quantitative easing as well as low interest rates to escape recession via emergency expansion, the Fed made history by being willing to spend its way out of any economic crisis, stabilizing markets and causing stocks to rapidly appreciate in value.
However, with potential for recession and stagflation around the corner in the US economy, the Fed’s ability to play monetary savior is now severely restricted. With annual inflation over 9%, at 40-year highs, the Federal Reserve is forced to confront hyperinflation threats, even at the expense of consumers and businesses. The Fed won’t be able to rescue the markets with its usual dovish tricks because this time the contraction is of their own making, as a sort of necessary evil. This is incredibly bearish for US indices, because there will likely be no multi-trillion-dollar last-ditch effort to prop up corporate share prices this time.
How Long Will This Last?
Unfortunately, it appears that both the US’ and the global battles against high inflation are just beginning. With the Federal Funds Rate currently hovering around 1.75% as inflation surpasses market forecasts, and the Federal Reserve reportedly considering a full 1% rate hike with many more hikes left to go, US indices are seemingly destined for a prolonged bear market. While it is virtually impossible to know when the stock market will hit bottom, with much disappointment for short-term bulls likely ahead, long-term investors can take heart, knowing that this can also mean myriad discounted buying opportunities over the next few years.
This morning saw demand for USD rapidly pick up steam as US inflation data came in hotter than expected. Month-over-month CPI had been forecast to rise by 0.7% in May; at 8:30 am Eastern Time, the Bureau of Labor Statistics revealed that it had increased by 1%, or 8.6% year-over-year, a forty-year high. Likewise, Core CPI (which excludes food and energy prices) was forecast to rise by 0.5% month-over-month, instead hitting 0.6%. On this news, the DXY is up 0.8% and has risen over the 104 level intraday, as EURUSD is down 1% and the S&P 500 is down nearly 3%. With this context in mind, let’s discuss 3 ways to capitalize on inflation now.
Trade Major Pairs
This CPI news is a huge fundamental catalyst for USD pairs since it verifies that the US economy is indeed still overheating, validating further interest rate hikes by the Federal Reserve. This is very bullish for USD, which makes buying the USD against other currencies even more appealing. If traders are searching for optimal USD pairs to take positions in, a good place to start is by locating pairs where analysis leans in USD’s favor to the greatest degree possible.
Some such options include a) shorting GBPUSD and EURUSD, which receive -7 (‘strong sell’) and -5 (‘sell’) signals, respectively, from the EdgeFinder, and b) going long on USDJPY, which receives a 4 (‘buy’) EdgeFinder signal. Because USD experienced so much buying pressure this morning, conservative traders may want to find an opportune point of entry by conducting technical analysis, e.g., waiting for a pullback and retest of key support/resistance.
Though admittedly a controversial opinion, I am waiting for an optimal point of entry to purchase gold against USD. XAUUSD experienced quite the selloff this morning before a startling recovery, jumping from a low of 1825 to hovering around 1855 at the time of writing this. This jump was seemingly prompted by finding support around the 1830 level, a clear zone of support on a 1-hour timeframe.
I interpret fundamentals being bullish for XAUUSD due to demand for the precious metal in several different industries and its historical status as a safe haven investment in times of economic crisis. There have been periods where gold’s rise in value does not correlate with USD depreciating in value, which is helpful to consider in cases like these. According to the latest COT data, institutional traders are similarly long on both USD (76%) and gold (73.56%). I am planning to purchase XAUUSD if price action retests the trendline depicted on the 1-day timeframe above, though this opportunity may not come if demand continues to grow quickly.
Invest in the Stock Market
Though it may seem strange in the face of persisting hyperinflation and potential for recession, economic downturns and stock selloffs do present myriad buying opportunities for long-term investors. If you are not planning on retiring for decades, you can utilize dips in the stock market and indices to build wealth over time, assuming you are willing to sacrifice immediate results. For example, when the Dow plummets over 600 points like it has today, investors can seize these events as opportunities for cheap purchases that will yield returns years down the road.
If your investment portfolio keeps crashing in the meantime, this does not have to be discouraging since they are merely unrealized losses; they will likely grow in value through the decades if you are invested in index ETFs and other trustworthy funds. Any further selloffs present even more opportunities for regular, small purchases. (However, investing in individual stocks is a completely different story, and I personally believe that even the most skilled retail investors are not sufficiently equipped to handle the inherent risks involved.)