Did you hear that big sigh of relief from Wall Street this morning at 8:30? I know I heard it all the way here in Cincinnati.
That was the sound of Wall Street analysts watching the latest inflation data cross the headlines on their screens. Within minutes, the Nasdaq 100 and other indices, especially the Russell 2000 Index ETF (IWM), shot higher.
That’s the “Hope Trade” kicking in.
Here’s why.
The latest Consumer Price Index (CPI) was reported to increase 0.0% from last month, compared to economists' forecasts of 0.1%.
The same report showed that prices are only 3.3% higher than a year ago, which was much lower than the 3.5% expectations.
The message in those two data points is that inflation continues to fade. We’re not paying less at the pump or the store, but at least prices aren’t going up as quickly as they were two years ago.
The point that investors are taking from this is that interest rates are coming down sooner rather than later.
That’s where we are with the Federal Reserve (Fed) trade right now. Investors have been buying stocks for the last two months on the “hope” that the Fed will lower rates sooner rather than later.
What’s the benefit of that? Lower rates mean that mortgage rates come down, car loans get cheaper, corporate financing gets easier—all the things that make consumers spend and the economy grow.
This morning’s CPI data shifted the expectations for a rate cut forward by two months. This is why stocks are on fire this morning.
Before the CPI hit, the bond market was forecasting that the first interest rate cut would happen at the Fed’s November meeting.
Just minutes after the CPI, the expectations have shifted to the Fed lowering rates at the meeting in September, kicking off the “Hope Trade.”
As always, there’s “Hope” and then there’s “Reality.”
Small-cap stocks have been trailing the rest of the market for all of 2024. Currently, the IWM is showing a year-to-date return of 3.59%, and that’s with this morning’s 3% rally. So, the small caps have been breaking even at best while the rest of the market is sitting at all-time highs.
That’s the “reality” of this market.
We’ve seen the S&P 500 move to its all-time highs because of a small group of stocks. NVIDIA and a handful of other stocks have made all the gains, while the rest of the market has been left behind. That’s not a sustainable situation.
Jerome Powell’s press conference this afternoon has the potential to change that.
Confirmation by the Fed Chairman that the central bankers are considering lowering rates sooner will flip the current reality trade into a bullish situation for stocks.
Instead of a few boats being lifted by the rising tide of the market, most stocks will begin to participate in the market rally, straight through the elections.
It’s a bold prediction, but it’s also a big ask from Chairman Powell.
What If the Fed Stays Cool to Lowering Rates?
It’s a valid question. Jerome Powell may stick to the “wait and see” approach that he has taken all year. Let’s face it, he was right. We’ve seen unexpected spikes in inflation data, and the jobs market hasn’t collapsed.
This is a Goldilocks scenario that has worked for months, just not for the entire market.
If that’s the case this afternoon, we’ll see the small-cap stocks return to their “reality trade” while the large-cap tech stocks continue to suck all the energy, and cash, from the rest of the market.
I’ll stress this again: that situation is not sustainable, meaning that we should expect volatility and selling pressure to return immediately.
Bottom Line: The Russell 2000 is the one index to look at after the dust clears from this afternoon’s press conference. It’s also the one index to buy if the Fed tips their hand on lowering rates today.
If the IWM remains above $207, we’re likely at the beginning of a real market rally that will focus on the rest of the market playing catch-up with the top performers in the Nasdaq 100. This would be the closest we’ve seen to matching last October’s rally in the Russell 2000. That “reality” trade pushed the small-cap index 28% higher in just 10 weeks.
About the Author
Chris Johnson (“CJ”), a seasoned equity and options analyst with nearly 30 years of experience, is celebrated for his quantitative expertise in quantifying investors’ sentiment to navigate Wall Street with a deeply rooted technical and contrarian trading style.