History Insight – Stocks Rise Before Inflation Falls

Here comes another high CPI inflation report (Thursday, 10/13). Expected: An 8.1% annual rise. The only visible good news is the CPI has been at the 8+% level since March.

Okay. But when will the rate decline, so stocks can rise again?

Well, here’s some good news. History offers a bullish insight – that rising stocks precede the inflation rate decline. Why? Because Wall Street is focused on the future. When a declining inflation rate outlook forms, stock buying begins.

History provides the proof

The year, 1965, was the beginning of the long inflation bout that ended in 1982. At the time, economic growth was high and U.S. corporations were leading the world. However, the inflation rate had started rising. Therefore, the Federal Reserve decided to tighten money. (At the time, the Fed operated in secret, so Wall Street had to interpret shifts in interest rates and money supply.)

In early 1966, the stock market started its nine-month decline. Inflation continued to rise, as did the Federal Funds rate.

Then, surprise! In early October, the stock market began to rise. However, inflation and Fed Funds stayed up, not reversing in earnest until January 1967. When it became clear that both were in a downtrend (in March/April), the stock market had already recovered its previous nine-month decline.

Moreover, as is common following a significant, protracted stock market decline (like today’s), the new bull market emerged as dramatically different than the 1963-1965 one. Out went the blue-chip stalwarts, in came the growth innovators. Large gains were concentrated in smaller and mid-sized companies, and the action produced the label, “Go-go” stock market. The accompanying investor attitude would last through 1969.

Here is a graph showing the 1963-1968 period for the U.S. stock market (all U.S. stocks), the CPI (all items), and the Federal Funds rate.

Note: Real (inflation-adjusted) GDP topped out in 1966 with an impressive 8.5% growth rate. It then declined, bottoming at 2.7% in late 1967. Here is the graph above, overlaid with the real GDP growth rate. Obviously, waiting for falling GDP growth to sell stocks or rising GDP growth to buy is a losing strategy.

The bottom line – The stock market anticipates, so don’t wait for the dust to settle

Often, we hear or read after a major trend change, “No one could have known.” Actually, yes, many investors do foresee what is coming. While it’s likely not the same individuals for each major move, the stars always align for some. After all, someone must initiate the buying or selling needed to reverse a trend.

So, is now the time to own stocks?

Looks like it. Even as the Fed continues to raise interest rates and the inflation rate remains high, there are clear, positive changes taking place. Then there is that “only visible good news” – that the inflation rate, while high, hasn’t increased for months.