As we head into the very important CPI Report on Thursday morning, there is a very intriguing market battle developing. General expectations are that CPI will likely be on the soft side and indicate that inflation continues to slow. This has been the primary market focus for quite a while, and there has been significant movement on every CPI report so far this year.
There are several questions that traders are pondering. The first is whether or not the market has already discounted a weak CPI report. The market has had big positive reactions to a weak CPI recently, but this time there is a substantial rally into the report, and the good news is being discounted.
This is typically a setup for a sell-the-news reaction, and that is even more likely as the Fed shifts its concern to employment-related inflation, which is still fairly strong.
The bulls say, 'not so fast.' While a soft inflation report is anticipated, there is still very poor positioning. According to both Goldman Sachs and JPMorgan, there is aggressive shorting of technology names by hedge funds. When this occurred back in July, there was a huge counter-trend rally that convinced many folks that the bear market had ended. That was not the case, but there was some big upside as large funds covered shorts and tried to add long exposure.
The bulls are hoping that poor positioning will offset a sell-the-news reaction when the CPI hits tomorrow.
Of course, if the CPI does come in hotter than expected, then that will completely change the dynamics. It will be a real surprise, but at least there will be some shorts to provide support if there is a big drop.
A soft CPI report may not have any real impact on what the Fed is doing over the next several months, and we will hear about that from various Fed members quite soon. That is the other big risk for bulls at this point.
Earnings season starts on Friday morning with banks, and that is going to refocus the economic debate on a potential recession rather than on inflation.
I've been reducing some long exposure today as there have been some nice moves in small-caps that I favor, such as Aehr Test Systems (AEHR) , CECO Environmental (CECO) , Catalyst Pharmaceuticals (CPRX) , and a few others. I have plenty of cash on hand and am hopeful that earnings season will provide some good entries.