Market Pauses, But For How Long?

Stocks slipped on Tuesday and Wednesday morning following a drop in retail sales, which fell 1.1% in June, driven largely by a slump in car sales. Earnings reports from Home Depot (HD) and Walmart (WMT) didn't help investing sentiment either amid flattening revenue growth and slowing e-commerce trends. The retail bonanza continues this morning with earnings from Target (TGT), Lowe's (LOW) and TJX Companies (TJX).

Fed minutes: Not a day goes by that there isn't some action, with the catalyst today being the Fed's most recent policy meeting. The minutes may show discussions about tapering monthly bond purchases, or just how divided FOMC officials are on the debate. Yesterday, Fed Chair Jerome Powell said the pandemic is "still casting a shadow on economic activity," and stock futures wavered around the flatline overnight as investors continued to size up the market.

The bulls: "We remain bullish on stocks (particularly cyclicals/value) thanks to a strong earnings season, signs of receding risk from the Delta variant and normalization of bond-equity correlation," wrote analysts at J.P. Morgan.

The bears: "The stock market is way overdue for a correction," said Jim Paulsen, chief investment strategist at Leuthold Group. "COVID cases continue to spike higher darkening economic reopenings, consumer data shockingly has collapsed recently - including consumer confidence last Friday and retail sales and homebuilders' sentiment. Several stocks have also stopped reacting positively to good earnings, inflation reports remain hot and Federal Reserve taper talk is everywhere."

Speaking of inflation, the key question regarding the surge in inflation recently, is whether this is a temporary spike – “transitory,” as President Biden assures us – or whether it is more structural and longer-term in nature.

As they did last month, the Biden administration assured us this big jump in July inflation was only “transitory” (temporary) as the economy continues to recover from the COVID lockdowns last year. Yet the fact is, the Biden administration does NOT know if it is temporary, and neither does anyone else. Only time will tell.

What we do know is that inflation was so low during the spring and summer of last year, largely due to the COVID recession and widespread lockdowns, and it is much higher this year. So the 12-month inflation comparisons are going to remain high, perhaps until the end of this year. This is referred to as the “base effect.”

While the base effect – with higher current monthly inflation figures replacing lower ones from last year – will be dissipating in the months to come, it is important to note that even if price growth is slower over the next few months, reported 12-month inflation rates will still be high. Headline CPI is already up enough in the first seven months of the year that if price increases were to drop to zero on a monthly basis, headline inflation would still be 4.1% for the year.

However, not all commodities have continue there rise. Some are down, such as oil and lumber. Investors should pay close attention to what happens during the next few months. A correction to the market will not be a surprise.

Sources: Seeking Alpha and Gary D. Halbert.