Good News on Inflation Stops Working
Weak retail sales gapped the market up but it rolled over anyway.
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The only major index positive on Friday was the Russell 2000 (IWM) with a gain of about 0.5%. That small-cap strength kept breadth positive with roughly 52% of stocks in the green.
Even though the Russell made a new all-time high, there are only around 170 stocks at new 12-month highs against 100 at new lows. That is not what you normally see when the S&P is sitting at a record. A market making new highs with that few individual stocks doing the same is narrower than the index level suggests.
I noted that Investor’s Business Daily increased its suggested market exposure to 80% to 100% due to strength in the index. That makes sense for a reactive model that uses the indices but my focus is buyable setups and I see few in this market. The indices may look pretty good but it is a tough slog for stock pickers.
Narrative May Be Turning
The big news was weaker-than-expected retail sales. That is the third report this week reinforcing the story that inflation is cooling, after CPI came in as expected and PPI came in flat. The market gapped up on that news at the open but it quickly went negative and bonds traded poorly.
All week the market has treated soft data as good news because it softens the risk of a rate hike. Friday it got the softest data of the three and could not hold the gains.
At some point slowing growth and a lack of pricing power stop being an inflation solution and become an economic problem. A labor market that lost 23,000 jobs in July, with downward revisions taking another 103,000 off the prior two months, plus a consumer pulling back on spending, is not a picture of an economy that simply cooled to the right temperature. It is a picture of one losing momentum.
The bad-news-is-good-news trade works until the news gets bad enough that the reason for the rate relief becomes the new worry. We may be closer to that line than the last two weeks of price action suggested.
If the economy becomes so weak that the odds of a Fed rate hike go to zero that is unlikely to be a major market positive.
Where Concern Showed Up
I have been writing that a lack of catalysts combined with negative seasonality would eventually put pressure on this market. That did not happen Thursday, when the S&P closed at a record but there were signs of it Friday.
The rotation into small caps prevented widespread damage, and that rotation has been the thing holding this market together for weeks. Money leaving one group keeps finding another, so the indices never break even when individual groups do. That is a healthy condition and it is also the condition that has been masking how narrow the participation actually is. The new highs and new lows figures are the evidence of odd action under the surface. A record in the S&P and an all-time high in the Russell should produce far more than 170 names at new highs. It did not.
Game Plan
I maintain my cautious view. Cash levels are high and I am doing little buying.
I am seeing some weakness in names I like, but it is not extensive or deep enough to push me toward accumulation. That is the frustrating part of this stretch. The stocks I want have not come in far enough to be interesting, and the market has not given me the kind of pullback that creates the entries I am waiting for.
Next week is peak vacation season on Wall Street and it is likely to be painfully slow. Monday has nothing. Tuesday brings housing starts and Home Depot (HD). Wednesday delivers the FOMC minutes along with Target (TGT), Lowe’s (LOW) and TJX Companies (TJX).
The retailers matter more than usual now. A weak retail sales report followed by four large retailers describing what they are actually seeing will tell us whether Friday’s number was noise or the start of something. That is a real catalyst in a week I expected to be empty, and it hits the issue the market is now watching closely.
So far, this market is holding up better than I expected. I do not think it has the energy to push much higher from here, but I have been wrong about the near term for two weeks running and I am not going to pretend otherwise. What I am not going to do is force entries into thin August trading because a market I expected to break has refused to.
Have a great weekend. I’ll see you on Monday.
At the time of publication, DePorre had no positions in any securities mentioned.
