Strategists explain why falling inflation won’t help stocks anymore

The stock market displayed a mix of gains and losses during Wednesday’s session as investors navigated through the latest Consumer Price Index (CPI) data, as per Sevens Report.

The ultimately edged higher, closing with a modest gain of 0.38%. The day began with optimism as the headline July CPI figure came in slightly below expectations, marking the first time inflation fell below 3% since early 2021. However, the core CPI remained in line with estimates at 3.2%, more than 1% above the Federal Reserve’s 2% target, which led to a more cautious market sentiment.

The S&P 500 opened the session with a strong rally, driven by the positive headline CPI numbers. However, the in-line core CPI figure tempered enthusiasm, particularly among investors who had been hoping for a clearer signal of disinflation. This cautious tone led to a brief period of flat trading, but as the day progressed, dip buyers stepped in, pushing the S&P 500 to new weekly highs. Despite these gains, the absence of a strong bullish catalyst saw the market pull back slightly in the afternoon before settling just above 5,450.

Sector performance and trading dynamics

The market’s sector performance was mixed, with the leading the way with a 0.61% gain, while the Nasdaq remained flat, and the fell by 0.52%. Financials were the standout sector, driven by strong earnings from insurance companies, particularly Progressive, which saw a 5% rally.

However, sectors like communications and consumer discretionary lagged, weighed down by concerns over potential regulatory actions against Alphabet (NASDAQ:) and upcoming retail earnings reports.

Why falling inflation no longer boosts stocks

As per Sevens Report, the decline in inflation, while historically a positive for stocks, has now become an expected outcome. This shift marks a significant change in the market’s behavior over the past 18 months when falling inflation consistently provided a tailwind for equities.

The strategists explain that with inflation now at relatively normal levels, the potential for it to surprise markets on the downside has diminished. As a result, the market’s focus has shifted to other factors, such as economic growth and Federal Reserve policy. With inflation expectations already priced in, only data that significantly deviates from expectations—either much weaker inflation or stronger growth—will move the market.

Potential catalysts for future market movements

Looking ahead, the strategists emphasize that the next potential market catalysts will be data on economic growth and the Federal Reserve’s policy stance. Key economic reports, such as retail sales and manufacturing indices, along with Federal Reserve Chair Jerome Powell’s address at the Jackson Hole symposium, will be closely watched.

If growth data is strong and Powell leaves the door open for more significant rate cuts, it could reignite a rally in the stock market. However, the strategists caution that if growth disappoints or Powell strikes a more neutral tone, the recent market bounce could quickly reverse. This underscores the delicate balance the market is currently navigating, where the margin for error is slim, and the potential for volatility is high.