Strategists Explain Why Falling Inflation Will Stop Helping Stocks Via Investing.com

The stock market posted a mix of gains and losses during Wednesday’s session as investors navigated the latest consumer price index (CPI) data, according to the Sevens report.

It eventually edged higher, ending with a modest gain of 0.38%. The day started on a positive note as July’s headline CPI came in slightly below expectations, marking the first time inflation fell below 3% since the start of 2021. However, core CPI remained in line with estimates of 3.2%, more than 1% above the Federal Reserve’s 2% target, leading to more cautious market sentiment.

The S&P 500 opened the session with a strong rally, driven by positive CPI figures. However, the in-line core CPI figure tempered enthusiasm, particularly among investors hoping for a clearer signal of disinflation. That cautious tone led to a brief period of flat trading, but as the day progressed, buyers stepped in, pushing the S&P 500 to new weekly highs. Despite these gains, the absence of a strong bullish catalyst saw the market pull back slightly in the afternoon before settling just above 5,450.

Sector performance and trading dynamics

Market sector performance was mixed, with the leader gaining 0.61%, while the Nasdaq was flat and down 0.52%. The standout sector was financials, driven by strong gains from insurance companies, particularly Progressive, which posted a 5% increase.

However, sectors such as communications and consumer discretionary lagged behind, weighed down by concerns over potential regulatory action against Alphabet (NASDAQ: ) and upcoming retail earnings reports.

Why falling inflation no longer boosts stocks

According to the Sevens Report, falling inflation, while historically positive for stocks, has now become an expected outcome. This shift marks a significant change in market behavior over the past 18 months, when falling inflation has consistently provided a tailwind for stocks.

Strategists explain that with inflation now at relatively normal levels, its potential to surprise bear markets has diminished. As a result, the market’s focus shifted to other factors, such as economic growth and Federal Reserve policy. With inflationary expectations already baked in, only data that deviates significantly from expectations—either much weaker inflation or stronger growth—will move the market.

Potential catalysts for future market movements

Looking ahead, strategists point out that the next potential market catalysts will be economic growth data and the Federal Reserve’s policy stance. Key economic reports such as retail sales and manufacturing indexes, along with Federal Reserve Chairman Jerome Powell’s speech at the Jackson Hole symposium, will be closely watched.

If growth data is strong and Powell leaves the door open for more significant rate cuts, it could reignite a stock market rally. However, strategists warn that if growth disappoints or Powell strikes a more neutral tone, the market’s recent rally could quickly reverse. This underscores the delicate balance the market is currently navigating, where the margin for error is thin and the potential for volatility is high.