We might sound like a broken record here, but stocks gained again last week, with the S&P hitting more new highs, up to 24 now on the year with a gain of more than 12% year to date. Incredibly, stocks are up more than 30% from the April 8 closing low for one of the best five-month rallies in history.
Papa Dow Joins the Party
It took a lot longer than most expected, but the Dow Jones Industrial Average (aka Papa Dow) finally joined the party last week and hit a new all-time high. In fact, it closed above the milestone level of 46,000 for the first time ever. Why did it take so long? It’s simply a function of what is in the index: the Dow has more weight than the S&P 500 in lagging healthcare stocks and less weight in leading technology stocks.
Here’s a big table we put together that looks at Dow milestone levels. Yes, as prices go higher, the percentage gain needed to hit the next milestone is smaller. What stands out to us here is it took nearly nine months to go from 45k to 46k. Now look at the past few times the Dow went at least six months without a new milestone level. It tended to hit multiple new milestones quite quickly. Could that happen again? We wouldn’t want to bet against it.
Age Is Just a Number
We didn’t know it at the time, but a vicious nine-month 25% bear market ended on October 12, 2022. Nearly three years later stocks are up close to 85%, but the big question is how much time is left? Of course, no one really knows, but we would side with this bull market lasting a lot longer than many out there expect.
Here’s an updated chart we’ve shared many times in the past few years, but we wanted to share it again. At the start of this year, we noted that the third year of bull markets tended to be choppy and frustrating, and we were on record that we expected some volatility at some point during the first half of the year. Well, we saw that and then some with the near bear market in April, but history says if you can get past that choppy third year, things tend to get better.
We’ve said many times that bull markets are like cruise ships—once they get moving, they are hard to stop and very hard to turn around. Looking at history, we’ve found five other bull markets that made it to their third birthday going back 50 years and the average one made it to eight years, with the shortest a still impressive five years.
The good news is the returns in year four have tended to be quite impressive, something to look forward to if you are bullish. George Orwell once said, “To see what is in front of one’s nose is a constant struggle.” Well, we are in a bull market and it is right in front of our noses, but that can be hard to see sometimes.
The Fed Is Going to Bet on Transitory Inflation
Inflation’s running quite hot, but the Federal Reserve (Fed) is going to cut interest rates next week for two reasons: 1) the labor market is weak; 2) they’ll argue that hot inflation is transitory.
Let’s start with the inflation data. The Consumer Price Index (CPI) for August showed that inflation is running hot. Headline CPI rose at an annualized pace of 4.7% in August on the back of hotter food and energy inflation. The index is now up 2.9% over the last twelve months, the fastest pace since January. The Fed tends to focus on “core inflation,” which strips out volatile food and energy prices, but that was hot too. Core CPI rose at an annualized pace of 4.2% in August and is up 3.1% over the past year. A year ago, in August 2024, core CPI was 2.6% and trending lower. That’s not the case now, as inflation remains well above the Fed’s target of 2% and crucially is moving in the wrong direction.
Blame Tariffs, but That’s Not the Only Cause
The most obvious source of heat is tariffs, and it’s showing up where you would expect it to—in durable goods. Here’s how CPI for durable goods has moved:
- August: +3.4% annualized pace
- Last 3 months (June – August): +2.8% annualized
- Last 12 months: +1.5%
There’s no question that we’re seeing accelerating durable goods inflation on the back of tariffs. Here’s a look at annualized inflation over the last three months for several categories within durable goods:
- Used cars: +3.4%
- Apparel: +4.1%
- Household furnishings and supplies: +7.3%
- Tools and hardware: +11.8%
- Video and audio products (like TVs): +10.1%
Keep in mind that prices for durable goods were actually falling prior to March, reverting to their pre-pandemic trend after the big spike in 2021–2022. So the pickup in inflation is a big reason why overall inflation numbers are going the wrong way. At the same time, tariffs should only have a one-time impact on prices, unless tariffs continuously ratchet higher. That means any tariff-related inflation should be “transitory” (though it may show up over the course of several months). The Fed is likely to make this argument, allowing them to look past elevated inflation.
But tariff-related inflation is not the only source of inflation heat. The two other big pieces of the inflation basket are housing (shelter) and services outside of housing. We’ve written a lot about housing over the last few years, in particular how official shelter inflation has a severe lag to what’s happening in real time. Until last year official statistics were still showing elevated shelter inflation, but that was capturing what happened a couple of years ago when rents were rising. Private data indicates that rents have been cooling for over two years now. The good news is that official inflation data is finally starting to reflect that reality and is a major source of disinflation. (Rent and owners’ equivalent rent make up 44% of the core CPI basket, and so it matters a lot.) Rents did pick up in August but that’s likely to reverse given what we’re seeing in the private data.
The problem is services outside of housing, including things like transportation services, pet services, personal care, and medical care. Normally, you’d expect to see elevated inflation in these categories when the labor market is running hot—if people earn more, they’ll tend to spend more on these services (like in 2021–2023). But the labor market is clearly running weak, and so it’s bit of a puzzle as to why services inflation remains elevated. But the reality is that it is, and CPI for services excluding housing has been accelerating recently:
- August: +4.0% annualized pace
- Last 3 months (June – August): +4.2% annualized
- Last 12 months: +3.3%
For perspective, CPI for services ex housing ran at an annualized pace of 2.2% in 2017–2019.
None of this is good news. And it’s not because a few items are pushing inflation higher. Inflation is broadening: 60% percent of items had at least a 3% (annualized) price increase over the last month—it was below 50% earlier this year.
The Fed’s Case for Cutting: A Weak Labor Market
August payrolls were weak, especially with revisions and a higher unemployment rate, and that pushed investors to price in a 100% probability of a rate cut at the Fed’s meeting this week. The latest report on unemployment claims also showed a concerning increase last week, indicating more workers got laid off and filed for unemployment benefits. Claims are now well above levels we saw during this same week in 2023–2024 and even 2018–2019. Granted, this is only one week of data (and driven by a large increase in claims from Texas) and so it’s an open question whether it’s the start of a trend. Still, it only bolsters the Fed’s case for cutting rates on the back of labor market weakness.
Markets currently expect the Fed to start a series of rate cuts beginning in September, taking the Fed policy rate from 4.4% to below 3% by the end of 2026. And investors don’t expect rates to go back up until at least 2028, and only gradually. In other words, markets expect the Fed to cut rates quite rapidly over the next year or so. But this is where there may be a disconnect between what the market expects and what Fed members are thinking. Given inflation heat, the Fed may not be ready to commit to a series of rate cuts beyond a couple of more this year, at least not as much as the market expects.
Nevertheless, the big picture is that the Fed is going to start cutting rates once again after a nine-month pause, even as inflation remains elevated (and going in the wrong direction). That is bullish for the market. It means the Fed’s priority is to protect the labor market (and the economy) even at the risk of prices running hot. There’s a reason why stocks continue to rally and make one new all-time high after another, and the profit outlook really hasn’t dimmed.
The Fed’s Case for Cutting: A Weak Labor Market
August payrolls were weak, especially with revisions and a higher unemployment rate, and that pushed investors to price in a 100% probability of a rate cut at the Fed’s meeting this week. The latest report on unemployment claims also showed a concerning increase last week, indicating more workers got laid off and filed for unemployment benefits. Claims are now well above levels we saw during this same week in 2023–2024 and even 2018–2019. Granted, this is only one week of data (and driven by a large increase in claims from Texas) and so it’s an open question whether it’s the start of a trend. Still, it only bolsters the Fed’s case for cutting rates on the back of labor market weakness.
Markets currently expect the Fed to start a series of rate cuts beginning in September, taking the Fed policy rate from 4.4% to below 3% by the end of 2026. And investors don’t expect rates to go back up until at least 2028, and only gradually. In other words, markets expect the Fed to cut rates quite rapidly over the next year or so. But this is where there may be a disconnect between what the market expects and what Fed members are thinking. Given inflation heat, the Fed may not be ready to commit to a series of rate cuts beyond a couple of more this year, at least not as much as the market expects.
Nevertheless, the big picture is that the Fed is going to start cutting rates once again after a nine-month pause, even as inflation remains elevated (and going in the wrong direction). That is bullish for the market. It means the Fed’s priority is to protect the labor market (and the economy) even at the risk of prices running hot. There’s a reason why stocks continue to rally and make one new all-time high after another, and the profit outlook really hasn’t dimmed.
This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
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