This Is What 'Complete Victory' Looks Like for the Fed
Editor's note: You can still find ways to profit even as inflation rages on...
The Federal Reserve has been easing its aggressive rate-hike policy over the past few months, but the central bank is still nowhere near its 2% target rate. That has left many investors unsure about where the economy is headed next.
Ten Stock Trader editor Greg Diamond argues that history holds the key... Historical cycles show us that the Fed is actually on track to conquer today's sky-high inflation... That's why he believes investors must examine past inflation cycles in order to understand how to navigate the ongoing economic chaos.
In today's Masters Series, which is based on the December 5, 2022 Weekly Market Outlook issue, Greg talks about the Fed's ongoing battle with inflation... compares today's inflationary environment with past inflation cycles... and explains how understanding previous cycles can help investors move forward...
This Is What 'Complete Victory' Looks Like for the Fed
Bill Dudley once opined that in the battle against inflation, only "complete victory" will suffice.
Simply put, the former head of the Federal Reserve Bank of New York wants to see inflation come way down. And he doesn't want the Fed to move the inflation-target goal posts to get there.
For various reasons, the Fed currently has a 2% inflation target. With record-breaking inflation overtaking the global economy since 2020, some folks think the Fed should increase that target to claim victory.
Because inflation has been so rampant, some are suggesting that a return to the mean of 2% isn't going to happen.
Last year, I argued that the Fed must sacrifice growth and asset prices (namely, stocks) to fight inflation. Obviously, the central bank chose this path...
Stock prices are down, and the labor market has been tightening recently as well. While inflation is still high, it has been cooling off over the past few months.
Dudley is saying more of the same: Regardless of economic consequences, the Fed shouldn't move the goal posts on inflation until it reaches 2%.
But what will the central bank actually do?
Rather than answer this question with guesses and economist op-eds, I'm going to analyze inflation the way I analyze everything else in the market... through the lens of price action and time.
I'm going to dive into inflation cycles with more than 100 years of data. This will provide more insight than debating what Fed economists might think or do in the future.
Here's a chart of the year-over-year ("YOY") change of the consumer price index ("CPI")...
As you can see, this data goes back more than 100 years, to 1914... That's a lot of data to analyze. So I want to find a rhythm within this data that points to a larger inflation cycle in the U.S.
I plugged this data into a cycle software program to find the strongest cycles. And here's the result...
The blue-green line at the top is the single major cycle and projection line into the future based on the various cycles below it. It's pretty messy. So in the next chart, I cleaned up the data and zoomed in to show you how this cycle works.
To save time, I'm not going to cover every decade going back to 1914. But you can see how this inflation cycle is pretty accurate. Here's the inflation line and the projection line from 1965 to 1992...
The thin black line above marks the actual YOY change of the CPI. The blue-green line represents the major cycle we extracted (the projection line) from the CPI data in the previous chart.
As you can see, the projection line is quite accurate. Is it perfect? No.
Welcome to cycle analysis and trading in general. Yes, we strive for perfection... but we'll never get it. However, if we find an accurate correlation (like the one above), it improves our chances of making successful trades.
I'm showing you the past first for a reason...
The projection line I mentioned above marks important highs and lows. Later, I'll explain how this projection line can help us visualize the next few years.
Before we do that, let's continue looking at the past. Here's the inflation line and the projection line from 1993 to 2007...
Once again, note how the blue-green projection line is fairly accurate in predicting the yearly move of the CPI.
I'll zoom in even closer on the interval between 2015 and 2020...
The blue-green projection line above aligns with the swings shown here. It also warned of a massive move in inflation starting in late 2019.
Keep in mind that this is yearly data, so there's a lag. But looking at the big picture, this projection line on a yearly cycle has a high correlation with the actual CPI going back more than 100 years.
Now, let's look at the recent CPI and the corresponding blue-green projection line...
This cycle warned of a rise in inflation. And now (on the right side of the chart), you can see that it's tapering off. This indicates that inflation will subside in the big picture.
Will there be periods of higher inflation? Sure. Remember, this is a yearly cycle... The month-to-month data will be volatile. But generally speaking, we can expect inflation to start falling.
And we've seen that already.
So let's look at what the projection line is showing a few years into the future...
The chart above shows a big decline in inflation over the next year or so based on this projection.
So, will Fed Chairman Jerome Powell beat inflation?
Based on the cycles I've presented... it looks like he will. But also consider this...
If we removed the Fed from the equation, the long-term CPI cycle tells us that inflation will come down regardless.
How will this play out in the stock market, though? I'll have plenty to say about this in the weeks and months ahead.
To sum things up...
Will the Fed achieve complete victory? I don't know what that means exactly. But based on the cycles and price action, I'll be trading based on lower inflation, a possible Fed policy error, and massive price divergence in the stock market.
I'll be paying more attention to historical cycles than Fed opinions going forward.
And based on the cycles, we're nearing a monumental inflection point in the next few months...
Best,
Greg Diamond, CMT
Editor's note: Greg called the 2020 and 2022 crashes... and the rally we experienced earlier this year. And he just stepped forward to share an urgent new warning for 2024 – one that could help you potentially double your money 10 different times...
He recently hosted an online presentation to reveal how you can double your money over and over again without touching a single stock... no matter what happens next in the market. Catch up on the full details here...