For the past three years, the markets have been haunted by a particularly ghastly boogeyman – inflation. But today’s Personal Consumption Expenditures (PCE) report suggests that boogeyman has been officially vanquished. And with inflation normalized, it seems stocks are set to keep rallying to record highs.
Indeed, this morning’s inflation data showed that the Federal Reserve’s preferred inflation metric – the PCE price index – rose just 2.2% year-over-year in August.
That’s pretty incredible.
Just two years ago, during the summer of 2022, PCE inflation was running above 7%, its highest since 1981. Now it’s just a hair above the Fed’s 2% target and back to its long-term ‘normal’ range. Moreover, current estimates for September’s inflation rate are right at 2%.
In other words, inflation is normal once again – and back to the Fed’s target.
This is also wildly bullish.
Letting the PCE Data Light the Way
Red-hot inflation has been stymieing the U.S. economy for the past three years, mostly because the Fed has been fighting it by hiking interest rates. That has pushed up financing rates for everything from homes to cars, which, in turn, has largely frozen those markets.
But now the Fed is cutting interest rates. Just two weeks ago, it cut rates for the first time since the Covid crash in March 2020. Moreover, it cut by 50 basis points (versus the normal cadence of 25 basis points) and projected that it will keep cutting rates for the next two years. In fact, since the central bank’s initial cut, several officials have stated that they need to keep cutting rates to support the economy.
The Fed’s message has been clear. It is ready and willing to support the U.S. economy with consistent rates… so long as inflation doesn’t heat back up.
That second part is key. The Fed wants to cut rates to support the economy; that much is clear. But it won’t be able to do that if inflation rises again. At that point, the central bank would be forced to hike rates again to fight it.
Therefore, we believe that reinflation is the biggest risk to the U.S. economy right now. So long as that doesn’t happen, the Fed will keep cutting the rates, the economy will restrengthen, and stocks will go higher.
So long as we don’t get reinflation, all should be fine.
That’s why this morning’s inflation report is so bullish. It showed that we aren’t getting reinflation. The PCE inflation rate dropped from 2.5% in July to 2.2% in August. And it’s expected to drop again toward 2% in September.
Inflation is still falling. And it should keep falling because of what’s happening in Saudi Arabia.
Is Oil Headed Lower?
Oil is a huge part of the global economy. In some way or another, oil is an input for almost every industry in the world. As such, oil prices are a huge factor in all prices – and, by extension, inflation. When oil prices rise, inflation tends to rise, too. When oil prices fall, inflation usually declines as well.
And right now, oil prices are collapsing. They’ve dropped about 10% over the past month and are more than 20% off their early 2024 highs and more than 30% off their late 2023 highs. In other words, oil is essentially trading at a three-year low right now.
We think it will keep going lower because of what’s going on in Saudi Arabia as the world’s biggest oil producer is reportedly making a strategy shift.
In short, since late 2022, Saudi Arabia has been cutting oil production to support high oil prices. But those production cuts haven’t worked; oil prices have dropped about 30%. Now Saudi Arabia is reportedly accepting the fact that oil prices will just remain lower for longer. As such, it is pivoting its strategy to win in a low oil price environment. That involves boosting production to snuff out the competition and expand market share.
In other words, it seems Saudi Arabia is starting a global oil price war.
Something similar happened in 2014, when the country grew worried about U.S. shale producers taking too much market share. Saudi Arabia meaningfully boosted production. Global oil supply boomed. Oil prices crashed throughout 2015 and into 2016.
We think we’re due for a similar outcome this time around.
The Final Word
We expect a boost in Saudi oil production will start a price war over the next 12 months, which should lead to meaningfully lower oil prices.
If oil prices do plunge in that time, inflation rates will stay low. And if inflation stays low, the Fed will keep cutting interest rates, and the U.S. economy will keep getting stronger.
That, of course, means this record-setting market rally will likely continue.
So… don’t shy away from stocks right now just because they’re at all-time highs.
Instead, let the data be your guide. The bulk of it suggests that stocks will keep steadily rising for the foreseeable future.
That means it’s time to embrace this rally. But do so sensibly – by buying only the best-performing stocks with the biggest upside potential.
And for that, I suggest you learn more about some of the top stocks we’re watching right now.
On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article.
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