Forget Election Day, Tomorrow’s Inflation Report Will Be Critical

Stocks fell this morning (as we predicted yesterday) in response to election day uncertainty. The Dow, S&P, and Nasdaq Composite all traded lower as investors weighed political gridlock in Congress.

Treasury yields fell, limiting the market’s losses, but Treasury prices are only up slightly. Bulls would like to see a strong Treasury rally that lifts equities in the process.

Instead, bonds have remained down significantly over the last few weeks and could trend lower still in the face of rising volatility.

“Election results are still uncertain, but the red wave that models, investors, and betting markets anticipated did not materialize, and near-term, that will add to already elevated volatility,” wrote 22 Research’s Dennis DeBusschere.

Last night was full of surprises, including several unexpected Democrat wins and polling issues in several key states. Arizona’s Maricopa County once again had problems with voting machines, leading to calls of potential fraud from conservative voters.

The pivotal Georgia Senate race between Democrat Raphael Warnock and Republican Herschel Walker dented sentiment the most, though, and is now headed to a runoff.

“Right now we have less than 20,000 total votes still out to be counted. That’s not enough to change the race. So this is headed for a runoff,”  said Secretary of State Brad Raffensperger, noting that neither candidate will grab a 50% share of the vote.

The most likely outcome of the midterm elections seems to be a split Congress. And, ordinarily, the market has done very well when neither party has total control.

“Going back to 1951, a Democratic president with a Republican or split congress, the two most likely cases this election, has seen an average S&P 500 Index return of over 17% versus an overall average of just over 12%,” wrote LPL analyst Barry Gilbert.

But we aren’t in ordinary times. Inflation is high, labor is tight, and forward guidance for most major corporations looks terrible. 2023 is set to be a rough year by all accounts.

Political gridlock won’t do bulls any good if inflation continues rising. The market will find out whether that’s the case tomorrow morning when the October Consumer Price Index (CPI) is released.

“Inflation is enemy number one for the Fed, and if you see the core CPI print creep up, I believe that the market would have a negative reaction to that,” said AllianzIM strategist Johan Grahn said.

Dow-polled economists anticipate a core inflation reading of +6.5% year-over-year (YoY), down from +6.6% YoY in September. The headline expectation is +7.9% YoY, down from September’s yearly gain of 8.2%.

The Fed just raised rates by 75 basis points last week and bulls are hoping for a 50 basis point rate hike in December. If core inflation exceeds estimates, however, the case for a dovish hike next month would weaken substantially, likely leading to a swift stock selloff to last week’s lows (or even lower).


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