Welcome to a Major Summer Stock Rally

The stock market soared to fresh all-time highs today after a soft inflation report this morning and dovish commentary from the U.S. Federal Reserve this afternoon.

While some fear the market is frothy, we believe this is the start of a major summer stock rally because today’s inflation report and Fed announcement increase visibility and confidence in the Fed’s first rate cut coming in September. Stocks could advance strongly ahead of that.

The thesis is simple.

After falling throughout 2023, inflation had a bumpy start to 2024, forcing the Fed to delay anticipated rate cuts. But inflation is now back on track. Rates are broadly and strongly falling again. This trend should hold. If it does, within a few months, the Fed will have enough evidence that inflation is returning to 2% to cut interest rates.

Stocks will soar in anticipation of that first rate cut.

This thesis hinges on inflation continuing to fall. Today’s inflation report suggests it will.

Has the Fed Won?

Inflation dropped for the second straight month in May and could drop again in June, suggesting it is back on track after a bumpy start to the year.

CPI fell from 3.4% to 3.3% in May, after falling from 3.5% to 3.4% in April. According to the Cleveland Fed’s Nowcast model, CPI is expected to fall to 3.2% in June.

Therefore, inflation has fallen for two straight months and is likely headed for a three-month falling streak. This provides firm evidence that inflation is back on track to fall to 2% this year:

Core inflation has dropped to its lowest level since 2021 and is falling steadily.

Core CPI decreased from 3.6% to 3.4%, the lowest since April 2021. This is the second consecutive month that core inflation has dropped by 20 basis points, following six months of smaller declines.

Core inflation is at its lowest in three years, and the pace of decline is quickening. This suggests core inflation could fall back to 2% later this year:

Supercore inflation, which excludes housing, went negative monthly for the first time since 2021. It fell 0.04% month-over-month in May, marking its first decline since September 2021. The Fed closely monitors supercore inflation trends. Meaning that this drop will likely push them toward a rate cut sooner rather than later. Here’s a look at supercore inflation:

Inflation dropped in May because nearly every line item in the report decreased as a result of broad disinflation.

Food inflation fell from 2.2% to 2.1%. Shelter inflation decreased from 5.5% to 5.4%. Non-core commodities inflation (apparel, alcohol, recreational goods) dropped from -1.3% to -1.7%.

The only major category with a rising inflation rate in May was energy, increasing from 2.6% to 3.7%. However, oil prices collapsed in June, so energy inflation will likely fall.

Overall, we are seeing broad-based disinflation:

Perhaps most importantly, controllable inflation fell below 2% in May and is back to normal levels.

So we created a new sub-category of inflation called “controllable inflation,” which excludes food, energy, and shelter.

The Fed does not control food and energy prices. They increasingly do not control housing prices because of unique supply and demand dynamics in the market. Therefore, controllable inflation, which the Fed directly impacts, excludes food, energy, and shelter.

Controllable inflation dropped to its lowest levels in this cycle in May, has plunged over the past two months, is running below 2%, and is back to long-term normal levels. By this measure, the Fed has clearly won the inflation battle: 

Given these inflation dynamics, we think inflation will continue to fall in the coming months toward 2%, giving the Fed increased confidence that they can and will cut interest rates later this summer.

But what about the Dot Plot?

You may have read that the Fed’s new Summary of Economic Projections, or “Dot Plot,” was hawkish. It reduced the number of rate cuts projected for this year from three to one.

However, those projections were mostly filled out before today’s CPI report. Powell said in the press conference that most members did not update their projections after today’s inflation data. Therefore, the Dot Plot may already be obsolete.

The Final Word

Listening to Powell’s comments, we gathered that he is telling the market the Fed will respond to the data, so do not put too much stock in their projections. Instead, pay attention to the data. The data shows that inflation is falling faster than expected, so the Fed will likely cut sooner and more than expected.

That’s bullish.

After today, we have increased confidence that the stock market will soar this summer in anticipation of the Fed’s first rate cut in September.

Well-positioned stocks sensitive to interest rates, with exposure to the AI Boom (which continues with vigor—just look at Apple’s stock), and supported by strong fundamentals, could explode higher this summer.

Click here to check out a few stocks we recommend for a summer to remember in anticipation of these rate cuts.

On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article.

P.S. You can stay up to speed with Luke’s latest market analysis by reading our Daily Notes! Check out the latest issue on your Innovation Investor or Early Stage Investor subscriber site.

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