The latest U.S. consumer price index (CPI) report showing a cooling inflation trend, followed by the favorable producer price index (PPI) report, represent a bullish one-two punch for the stock market.

The PPI released on Tuesday showed a distinct downward trend for the month of July, echoed by Wednesday’s CPI. (More about the CPI report, below.)

The twin data trends this week suggest that the Federal Reserve’s aggressive interest rate hikes over the past year are exerting their intended effect of curbing inflation without triggering a severe economic slowdown.

If inflation is under control, the Fed can shift its focus from fighting inflation to supporting economic growth.

The betting is that we’ll get a rate cut at the Fed’s next meeting in September. With both CPI and PPI data showing signs of easing inflation, the Fed is likely to conclude that it has more room to cut rates without risking a resurgence in inflation.

Forget the yabbering on television or the political headlines. Stick to the fundamental rules of investing. The textbook rules never change and right now, those rules are shining favorably on you.

When interest rates are lower, companies can borrow more cheaply to finance expansion, operations, and investments. This can lead to higher corporate earnings, which generally supports higher stock prices.

Lower interest rates often lead to higher valuations for stocks because the present value of future cash flows increases when the discount rate (which is influenced by interest rates) declines. This makes stocks more attractive relative to other investments, such as bonds, which offer lower yields when rates drop.

Liquidity: the lifeblood of markets…

Liquidity is a critical factor for the stock market, and it’s closely tied to the Fed’s interest rate policy. Liquidity refers to the ease with which assets can be converted into cash or used to make investments. In the context of the stock market, liquidity often comes from the availability of credit and the willingness of investors to deploy capital.

When the Fed cuts interest rates, it generally increases liquidity in the financial system.

Higher liquidity means there are more buyers and sellers in the market, which helps stabilize prices and reduces volatility. It also makes it easier for large investors to enter and exit positions without significantly impacting stock prices.

Lower rates reduce the cost of borrowing on margin, allowing investors to leverage their investments more cheaply. This can amplify gains in a rising market, driving stock prices higher.

When credit is cheap and abundant, corporations can access financing more easily, which they can use for stock buybacks, mergers, acquisitions, and other activities that pave the way for higher stock prices.

The CPI for July: good news…

The U.S. Bureau of Labor Statistics reported Wednesday that the annualized July CPI inflation rate fell to 2.9%, below expectations of 3.0% (see chart).

Core CPI inflation (excluding volatile food and energy components) fell to 3.2%, in-line with expectations of 3.2% and matching the number in June. This marks the first month with CPI inflation below 3.0% since March 2021.

Inflation still surpasses the 2% that was generally normal before the COVID pandemic, but it’s considerably slower than the 9.1% peak in 2022. If you hear a public figure decry supposedly rampant inflation, that person is either ignorant, divorced from reality, or purposely lying.

Today’s CPI report confirmed the bull case; the tailwinds for the second half of 2024 are accelerating.

The first rate cut since 2020 is virtually assured of happening next month, providing a shot of adrenaline for the economy and equities. Invest accordingly. Sectors that should benefit in the coming months include utilities, real estate, industrials, and cyclicals. These sectors were laggards in 2023; they’re rotating into the leadership for H2 and into 2025.

On Wednesday, the main U.S. stock market indices closed mostly higher as follows:

• DJIA: +0.61%
• S&P 500: +0.38%
• NASDAQ: +0.03%
• Russell 2000: -0.52%

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Editor’s Note: If you’re looking for ways to generate high but safe income, regardless of economic reports or market ups and downs, consider the advice of my colleague Robert Rapier.

Robert Rapier is the chief investment strategist of Utility Forecaster, Income Forecaster, and Rapier’s Income Accelerator.

Robert is one of the world’s foremost experts on energy and income investing, but his deep knowledge also extends into other profitable segments, such as artificial intelligence.

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John Persinos is the editorial director of Investing Daily.

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