THIS WEEK'S UPDATE

A little different format for the update this week as I want to cover a few topics I think

are important and relevant.  First, a very abbreviated market recap.  Stocks were mostly

up last week as the market breathed a sigh of relief on possibly seeing peak inflation.  The

market has run really hard the past few months and it wouldn't surprise me to see it take a

bit of a breather as we near the 200 day moving average on the S&P 500.  Today the 200

day moving average sits at 4,327.  As of this writing we are about 29 points below this.  

The 200 day moving average typically acts as support when the market trades above it and

resistance when it is trading below.  Sort of like a floor or a ceiling. We can (and probably

will at some point this quarter) break through the ceiling. However, these levels are often

tested several times before they crack.  I would love to see the market goes straight up from

here, but being practical, it isn't likely.  But, the market does what it wants and loves to prove

as many wrong as it possibly can.

Moving averages have become more relevant over time due to algorithmic trading. These

levels are programmed into the machines and when the market gets there, WHAM, a bunch

of computerized orders are triggered.  These numbers and levels only have merit because

people believe they have merit.  In reality, they are just numbers.  But, it works because

everyone believes it works and so it becomes a kind of self fulfilling prophecy.

This brings me to the first of two points I want to briefly cover today.  Cognitive bias.  Look

at the balls below.  At first glance, they appear to be three different colors.  In reality, the balls

are all the same color, but our brains see them as different colors.  The stripes covering them

are what makes them appear different colors.  Our brain expects them to be one way, so that is

how our lyin' eyes interpret them.  

We often have an underlying opinion of the stock market or economy.  Based on this opinion

we tend to fit data we come across to match our opinion.  We don't do it consciously, our brain

does all of this work behind the scenes.  Just like you didn't choose to see the wrong color for

the balls, you may not realize your cognitive bias.  I have learned over time that religion doesn't

fit well in investing. What I mean by that is one can't always subscribe to one way of thinking.  

One must be agnostic and believe what the data is telling them.  If there is a religion to investing

it would be discipline.  The discipline to not over invest in one area just because it is doing well

now,  the discipline to not cash out when things get a little rough or any other number of emotion

based decisions one can choose from.  

By the way, cognitive bias is involved in a lot more things than investing.  A simple example is

let's say you buy a new blue truck.  Suddenly, as you're driving to and fro you begin to notice how

many other blue vehicles exist.  Well, blue didn't suddenly become the most popular color vehicle,

you just happen to be thinking more about blue so you may notice it more. (Actually blue is the 6th

most popular color, white is number 1. You can thank me when you're driving around noticing car

colors and keeping tabs.)  But, this isn't meant to be psychology lesson.  Early in the year, inflation

numbers were ripping higher and that meant higher interest rates.  The cognitive bias of the market

looked at the inflation of the 1970s and early 80's Volcker era Fed and thought interest rates must go

up exponentially and crush asset values along the way.  I don't have a crystal ball, but I do have access

to data and the data says, at least for the time being, we have seen peak inflation.

This leads me to the second and final point I wanted to cover today. Inflation. Inflation is driving

stock prices this year.  Earnings should always drive stock prices, but we don't live in a perfect world.  

Earnings, by the way, were overall pretty good this past quarter.  You don't hear that on TV because it

doesn't sell ads. The consumer price index (CPI or measure of inflation) lags real-time data by 3-4

months.  Leading indicators for inflation have shown the underlying trend in inflation was substantially

lower than the “hard” data (CPI, PCE or PPI reports). Notice how many leading indicators of inflation,

including surveys, show as vast improvement.  July CPI (reported in August) is the first CPI print that

was not “hot."  Notice the trend below.

If hard data (“CPI”) lags soft data…Intuitively, Fed is not only watching “hard” data.  The above

shows that “hard” CPI reports lag even the surveys by 2 months. If this is the case, realized inflation

could be falling for 3-4 months and CPI report won’t show this for two additional months.  You get

the picture,  We don’t think the Fed is primarily watching CPI alone.  Since inflation is driving the

investment bus, moves in inflation are going to create moves in the market.  Thus if inflation begins

to fall the market could rally further.  One month doesn't make a trend, but commodity prices continue

to fall along with other indicators we follow.  



None of this means the market is going to move up in a straight line.  We are bound to see some back and

forth and historically (there we go with our cognitive bias) August - October are generally the worst months

of the year.  So, there may be a headwind or two, but if inflation declines and the Fed doesn't lose their minds

and push rates up a lot higher than they need to be markets will improve.

Stay tuned...