Let’s start with everyone’s favorite multi-year topic – inflation. Last Wednesday, the May consumer price index report was released. The overall feeling leading up to the report was that a mere inline result would be seen as positive.
The forecasted “inline number” that would be deemed positive was a 0.27% month-over-month reading:
This acceptance was most likely born from the belief that inflation is an important problem, though it is decreasing in priority:
Much concern leading into last week’s report was founded in recent Federal Reserve surveys indicating around 75% of companies have begun raising the price of goods due to tariffs.
Still, if in the face of that headwind, the actual CPI came in cooler than expected:
Even more promising, May’s Core CPI came in at less than half of what was expected, logging just a 0.13% month-over-month rise:
This included housing and auto insurance, which were 0.12% and 0.02% of the total, respectfully. So, if you remove those two pieces of the puzzle, inflation was actually negative in May, even in the face of tariff-induced price increases.
This data clearly indicates inflation’s continuing downward trend overall and has even more than offset any goods-related inflation.
Most promising is that housing has continued slowing its stubborn stickiness. Also, energy fell by 1%, new cars dropped 0.3%, and used cars sunk by 0.5%:
Taken together, this argues for a dovish Fed in 2026, which supports the current earnings expansion and offers more proof the market is already looking well ahead of today.
May’s CPI continues a string of “soft” readings, the longest since 2020:
To us at Cornerstone, this further exemplifies the perception gap we’ve been talking about for a while. So does the recent NFIB small business optimism survey. Decision makers are expecting more spending, more sales, and have a renewed sense of optimism:
These big improvements indicate that early April’s caution has transformed to May strength. There’s little reason currently to think the positive momentum will slow in June. Combine this with China trade talk progress and we think any near-term pullbacks will be shallow.
Some may wonder when it’s time for caution. We think it will be when people begin to say that nothing could go wrong in the market (i.e.-exuberance).
As we see here today, that thought process is clearly not in play. Investors have increased short interest in the S&P 500* to the highest level in five years:
However, we’ve previously shown historical data that was predictive of how waterfall declines like we saw in late March and early April typically lead to V-shaped rallies like we are currently experiencing:
So, let’s again rely on data to address the current popular “wall of worries” about rising yields, a weakening U.S. dollar, and falling oil prices. They couldn't be more wrong.
Many fear how Treasury yields have risen while the dollar falls:
This divergence is rare. Since the 1970s, it’s occurred just 16% of the time. Currently, it looks more like short-term noise than structural weakness.
But even if the divergence remains for a bit, it's not as negative as the financial media makes it seem. Stocks gained an average of 14% following three-month dollar declines combined with 10-year yield increases:
Combined with dwindling inflation, higher yields largely signal a stronger economic backdrop overall. Maybe surprisingly to some, this is now reflected in the Atlanta Fed’s second-quarter GDP forecast being above 3%. That's good news for earnings.
Considering that roughly 40% of the S&P 500’s revenues come from overseas, those profits in foreign currencies convert back into dollars, boosting profits in periods of a “weaker” dollar. That’s also good for earnings and provides an equity tailwind.
Lower oil prices are bullish for equities too. Over the last year, the price of WTI crude oil is down about 19%. Understanding the inflation news above, it might make sense why energy prices are deflating.
Our friends at MoneyFlows show why it matters in this context – real consumer spending grows 1.2% in years following bottom quartile oil price performance:
Since consumer spending accounts for 70% of our economic activity, stocks react well to increased outlays from savings in other parts of the consumer economy. Now it makes sense why sales expectations are reversing:
This bodes well for stocks because they do well after oil prices fall hard as consumers begin to deploy that capital elsewhere in the economy:
Additionally, technology stocks (the growth drivers of the equity market) outperform the market by 5.8% after big oil price decreases while defensive sectors lag:
The data since the late 1960s is clear. Increased consumer spending and strength in growth-oriented sectors create a risk-on environment, just like we’ve seen for the past couple of months.
So, most prognosticators got it wrong. But data allowed us to get it right.
To wrap up, for those who couldn’t believe two months ago that this data and environment would so quickly lead us to stocks hitting overbought territory, the last two months have been a great example of why it takes a data-driven plan to execute unconventional ideas.
“Overbought” may ignite fears, but markets tend to stay overbought for a while. Remember, it’s when they fall out of overbought conditions that profit taking trouble starts.
MoneyFlows’ trusty Big Money Index (BMI), which is a 25-day moving average of “big money” investor activity, sits at 83.2% currently:
That’s coincided with a 20% rally in the S&P 500 in just 41 days, marking one of its best three-month stretches in the last 40 years.
We know this hasn’t been a fluke by looking under the surface. Broad participation has driven markets higher:
We’re not surprised because extreme outflows like we saw in early April create an environment for this type of broad buying. And “overbought” doesn’t mean it’s time to worry. Since 2014, we've had 17 instances where the BMI went overbought. The average time spent there is 21 trading sessions, or about a month.
But in the most extreme markets like recently, it’s not unusual to surpass the 21-day average. Just look at the COVID pandemic, where the BMI stayed overbought for a record 87 days:
When the BMI falls from overbought, history shows profit taking will likely occur. But the data also says that isn’t happening yet, although it will:
But don’t be anxious. Zooming out further, it’s clear that stocks do well historically in the months and years following a 20% or more reversal in the S&P 500 in 41 trading days:
Notice that three months out and later, the historical winning percentage is 100%. Stay invested.
* Links to third-party websites are being provided for informational purposes only. CoreCap is not affiliated with and does not endorse, authorize, or sponsor any of the listed websites or their respective sponsors. CoreCap is not responsible for the content of any third-party website or the collection or use of information regarding any websites users and/or members.
*Past performance does not guarantee future results.
*Investing involves risk and you may incur a profit or loss regardless of strategy selected.
* The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
Securities sold through CoreCap Investments, LLC. Advisory services offered by CoreCap Advisors, LLC. Cornerstone Financial and CoreCap are separate and unaffiliated entities.