Those who are looking for inflation to take a back seat to other issues in the second half of the year are very likely be disappointed over the coming weeks……….It is very interesting to read and hear that so many pundits are now saying that inflation is not going to be a problem in the second half of the year…(or at least saying that it will move well down the list of concerns for the markets over the next six months). We understand why this shift in thinking is taking place, but the reason it is so interesting to us is that is is happening at a time when the commodity market is getting very oversold. In other words, the timing of this call might turn out to be quite bad.
As we said above, we understand why some pundits have changed their thinking on inflation. A lot of the economic data has been weak, long-term interest rates have come back down, the yield curve has become inverted, etc. Also, we’ve seen significant declines in many different commodities…including very high profile ones like oil, natural gas, copper, wheat, etc. Therefore, there are some very good reasons to think that inflation will die-out as the number one concern facing the markets going forward.
However, we think it is important to point out that at least some of the decline in many/most commodity prices was merely a move to work-off an overbought condition that existed in late-May/early-June…and an extremely bullish one in terms of sentiment at that time. If you’ll remember, the technical condition of the energy sector…as well as the uber-bullish sentiment that exited in early June was the reason that we pulled back from our bullish stance on the energy sector. Well, the same kind of overbought and over-loved condition existed in many other commodities at that time as well.
Don’t get us wrong, we are NOT saying that the entire decline in many commodities over the last month has been technical in nature. As we mentioned above, there HAS been a decline in demand for many of these commodities. Therefore, a good part of the decline has indeed been associated with this demand destruction. However, we DO believe that the technical condition that existed a month ago has made the breakdown in demand seem much larger than it really has been. Therefore, we also believe that the downside follow-through for many of these commodities is not going to be anywhere near as strong as some people believe…and therefore, we also believe that the decline in inflation fears will not be something that will continue for much longer.
As you can see from the chart below on the Bloomberg Commodity Index, the recent decline has taken it to its second most oversold level in a half-dozen years. Given that the only time it was more oversold was when the global economy had all but completely shutdown, we don’t expect it to become much more oversold than it already has during this time frame. Therefore, we expect that oil, copper and many other commodities will see a decent sized bounce over the coming days and weeks. No, this does not mean that they will all rise and takeout their 2022 highs before the summer is over. In fact, we have been saying for months that inflation would likely peak over the summer. However, we have also said that inflation would still stabilize at a much higher level than anything we’ve seen in 40 years. Therefore, we said, any sign that we’ve reached “peak inflation” is not something market participants should take much solace in.
What we’re trying to say this morning is that the commodity market has gone from being overbought….to now being quite oversold. Therefore, it should bounce back to a level over the coming weeks that should keep inflation on the front burner in the second half for those who follow the markets and the economy…even if many commodity prices do not run back up to their spring highs.
Over the next week or so, investors will be focused on the employment report (tomorrow)…and next week’s start to earnings season. However, they’ll also be looking at the CPI number that comes out next Wednesday…and we believe they will also be looking at a commodity market that is bouncing back from an oversold condition. That, we believe, will refuel the big concerns about inflation that have created headwinds for the markets all year.
Of course, we have not even talked about how the fact that the main reason for the rise in prices in two of the most important areas (food and energy) has been driven by supply issues, not demand issues…and thus they should almost certainly remain elevated for a long time. However, since we’ve harped on this part of the argument ad nauseam over the past several months, we won’t beat it to death again this morning…except to say this is another reason to think that inflation will remain a big problem for the markets in the second half of 2022.
Matthew J. Maley
Chief Market Strategist
Miller Tabak + Co., LLC
Founder, The Maley Report
275 Grove St. Suite 2-400
Newton, MA 02466
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