Inflation continues to trend at 40-year high levels while historic stock market indicators continue to warn of potential for downside risk.

Traders can only wait for stock market reaction to what lies ahead.

Expectations are for increased volatility until this market settles into a new chapter of history.

Traders wait for stock market history for direction

Last week, the U.S. Producer Price Index (PPI) and U.S. Consumer Price Index (CPI) data for September confirmed that inflation remains solidly in place and trending at a level not seen since the early 1980s.

The Federal Reserve (Fed) closely monitors core CPI which strips out volatile food and energy costs. Core CPI was more than expected.

The stock market reacted wildly to the strong CPI report that was released before the markets

opened on Thursday. Initially the markets fell 2.5% before recovering that loss and closing the day up 2.5%. This ripped through retail traders on both sides of the move.

“This type of dramatic intraday price reversal is rare, and has occurred only nine other times over the past 39 years,” said Mary Ellen McGonagle, Senior Managing Director of Equities at Simpler Trading. “The other times this occurred were during periods that were mostly closer to the lows in the markets such as 2009, 2018, and several times in late 2008.”

Mary Ellen isn’t contemplating any bottoming in the market in the near term. She doesn’t expect the market to hit bottom until inflation is under control. The Fed has stated strongly its plan to raise benchmark interest rates as much as needed to reverse rising interest rates.

“History aside, we’ll need to see a follow through day in the markets coupled with reports of inflation subsiding, before we could begin to consider a possible low in the markets,” Mary Ellen said. 

In the market today, the Dow closed at 30,185.82 points to gain 1.86% (adding 550.99 points on the day). The Nasdaq surged to 10,675.80 points for a 3.43% increase while the S&P 500 spiked 2.65% to 3,677.95 points.

A positive start to this week follows the biggest news for the U.S. markets last week that inflation remains elevated. With the Fed vowing to continue to raise interest rates to combat inflation, Mary Ellen said, the prospects of any pivot in the markets to a sustained uptrend are limited over the near term.

Earnings season presents flurry of price action

Traders could see a flurry of price action this week as earnings season revs up to report third quarter results.

High-profile companies reporting earnings include Netflix, Inc. (NFLX) and Goldman Sachs Group, Inc. (GS) on Tuesday followed by Tesla, Inc. (TSLA) and International Business Machines Corp. (IBM) reporting on Wednesday. These are just a few of the 150 companies due to release results.

The economic calendar – economic data, Fed meetings – is light this week which should allow third quarter corporate earnings reports tol take center stage.

“We anticipate that results will continue to come in above lowered expectations for many companies which, in turn, may spark short-term rallies in select stocks,” Mary Ellen said.

She said longer term investors might be better served remaining on the sidelines and preserving capital until the stock market exhibits characteristics of a new bull market.

“In addition to positive price action in the markets, we will need to see evidence that inflation is receding to confirm any signal of a new bull phase,” Mary Ellen said.

As the market works toward this possibility, she continues to update her watchlist of potential stocks that would be in a position to outpace the market once a bullish turn is cemented.