The news keeps getting better for investors.

The U.S. Bureau of Economic Analysis reported Friday that the personal consumption expenditures price index (PCE), a key gauge of inflation tracked by the Federal Reserve, further decelerated in August.

The “core” PCE, on which the Fed pays particular attention showed that core prices rose at an annual rate of 2.7% last month, just ahead of last month’s reading of 2.6% and matching the consensus forecast.

Core pressures, which exclude volatile food and energy prices, were up 0.1% on the month, compared to July’s 0.2% gain and the consensus estimate of 0.2%.

The BEA’s headline PCE eased to an annual rate of 2.2%, below the 2.3% forecast and down from the 2.5% pace posted in July. Prices were up 0.1% on the month, the BEA reported, following a 0.2% reading in July (see chart).

Source: U.S. Bureau of Economic Anaysis

The BEA also revealed that personal incomes for August rose 0.2%, down from the revised 0.3% pace in July, denoting softness in the labor market. Spending eased to a 0.1% rise versus the 0.5% gain over the previous month.

The upshot: the Fed was given even more elbow room to continue cutting interest rates.

The PCE measures changes in the prices of goods and services purchased by households and is the Fed’s preferred measure of inflation because it captures a broader scope of consumer spending habits. It accounts for adjustments in behavior, such as switching to lower-cost alternatives, making it a more comprehensive indicator than the more popularly known consumer price index (CPI).

A falling PCE implies that input costs are stabilizing or declining, offering relief to companies facing margin pressure. This directly benefits corporate earnings, which in turn puts upward pressure on stock prices.

What’s more, the decline in PCE also fosters a sense of economic stability. In 2022, when inflation was at its peak, fear gripped the market. Investors worried that rampant inflation would necessitate ongoing rate hikes, leading to a potential recession. These concerns drove significant volatility in stock prices, as uncertainty ruled the day.

A falling PCE sends a reassuring message to investors that inflation is no longer the looming threat it once was. This increased sense of stability boosts investor confidence and encourages more buying activity.

Historically, periods of falling inflation have been associated with stock market outperformance. Take the late 1980s and early 1990s, for example. During this time, inflation steadily fell, and the stock market delivered strong gains. Similarly, after the dot-com crash of the early 2000s, inflation began to cool, setting the stage for a sustained bull market in the mid-2000s.

The current environment is poised to mirror these historical trends. Certain sectors tend to benefit more from falling inflation than others. Growth stocks, particularly those in the technology and consumer discretionary sectors, stand to gain significantly. These sectors are sensitive to interest rates and consumer spending patterns, both of which are positively impacted by falling inflation and lower borrowing costs.

Industries like manufacturing and transportation, which are highly exposed to input costs, should see a boost as inflationary pressures ease. Lower input costs lead to higher margins, making stocks in these sectors more attractive to investors seeking value plays.

Read This Story: How to Beat Wall Street…Under All Investing Conditions

For investors, this is a perfect storm of good news. But volatility is likely to spike higher as the year draws to a close, amid a slew of headline risks such as the presidential election and geopolitical strife.

On Friday, the main U.S. stock market indices closed mixed as follows:

• DJIA: +0.33%
• S&P 500: -0.13%
• NASDAQ: -0.39%
• Russell 2000: +0.67%

As further evidence of sector rotation toward cyclicals, the Dow closed at a record high.

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John Persinos is the editorial director of Investing Daily. You can reach John via mailbag@investingdaily.com

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