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Higher Inflation and Interest Rates?

Consumer Price Index posted a rise of 0.5% in December 2021, as inflation came in slightly higher than expected, hitting a fresh four-decade high of 7% from a year ago. The core CPI ex-Food and Energy rose 0.6% last month, pushing the increase over the past 12-months to 5.5% from 4.9% or a 31-year high. Although elevated inflation can continue into 2022, investors appeared relieved that the December inflation numbers were not worse than anticipated.

Stocks closed off the session’s high of the day, with the S&P 500 Index adding 13.28 points or 0.28%, the Dow Jones Industrial Average rallying 38.30 points or 0.11%, and the Nasdaq Composite Index gaining 34.94 points or 0.23%. Commodities continue to rally, with WTI crude oil up 1.42 or 1.75%, Copper prices appreciating 0.15 or 3.33%, and the best performing S&P sectors today was the S&P Materials, rallying 0.90 or 1.01%. The 30-year US Treasury yield gained 0.01 or 0.05%, but the 10-year yield declined 0.21 or -1.20%. The US Dollar Index suffered a sharp decline of 0.72 or -0.76%.

The current financial market environment has become increasingly volatile, as evidenced by the speed and frequency of the rotations. Inflation numbers released today confirm the Fed, consumers, and investors are concerned about higher inflation and interest rates.

For investors, both measures can erode the valuations of growth companies, especially those that depend on higher future earnings growth rates. The enclosed technical study dating back to the early-1980s shows the core Consumer Price Index Core (CPI) rate of change (ROC) monthly trend against Nasdaq Composite and SPX Index and Large/Mid/Small-cap Growth Indexes and Large/Mid/Small-cap Value Indexes. The red-dashed vertical lines denote the market bottoms in the Core CPI rate just before the sharp rise, and the green-dashed vertical lines mark the tops in the Core CPI rate before a sharp decline.

Nasdaq Composite Index and Growth Indexes tend to struggle in relationship to Value Indexes during periods of rising inflation. If the Core CPI trends up to 6-7% or higher, growth stocks will likely underperform value stocks, at least on a relative basis. But as the Core CPI peak and trends lower, growth can begin to outperform value again. The overall market has held up well so far, probably because of a handful of mega-cap Technology names skewing the overall market. However, if the mega-cap Technology names begin to falter, this can trigger a deep and extensive correction in the broader stock market. On the other hand, if the Fed implements a soft landing and inflation peak and interest rates subside, then secular growth names will likely resume their leadership roles.

The intermediate-to-longer term stock trends remain bullish. Since the primary trends point to higher prices over time, it is wise to respect the prevailing trend. It is the short-term market volatility and market divergences that keep investors guessing.

For one, the core CPI 10-month rate of change has exploded higher along with the 10-year Treasury yield. Surprisingly, the 10-year Treasury yields 12-month rate of change continues to trend lower over the past few months.

Second, the Nasdaq Composite Index/S&P 500 Index relative trend has declined, but the Dow Jones US Large-Cap Growth/Large-Cap Value Index continues to trend higher as it clears above its 2000 all-time high.

Confusingly, the Dow Jones US Mid-Cap Growth Index/US Mid-Cap Value Index and Dow Jones US Small-Cap/US Small-Cap Value Index are showing lower-highs diverging from their larger counterparts.

A correction (5-10%) or even a deep correction (10-20%) can occur if inflation fears persist, higher interest rates (monthly rate of change), and concerns about a Fed policy mistake escalate into 2022. Would this correction, if it occurs, confirm yet another mid-term election year cycle low and set the stage for the resumption of the primary long-term bull trend?

Source: Courtesy of

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