One basic belief about the stock market is that higher interest rates and a hawkish Fed do not support higher prices. The higher the interest rates are, the greater the discount rate, and that lowers the present value of future earnings.
The math is simple, but this market doesn't seem to care right now. The headline Consumer Price Index number reported on Tuesday was higher than expected, but the most important issue is that it raised the likelihood of interest rate hikes of 25 basis points at the next three Fed meetings in March, May and June. Several Fed officials stressed that further rate hikes will be needed to gain control of inflation, and there are likely to be more speakers this week to reiterate the point.
Despite this clear obstacle, stocks are holding up very well. The bulls are primarily focused on positive price action. They see the technical action as predictive of more positive price action. They are counting on poor positioning to drive the market even higher.
The bullish narrative is that inflation is coming down, and the strong labor market is an indication that the economy is not going to collapse even with a hawkish Fed. It is a Goldilocks economic environment in which inflation is not too hot and economic growth is not too cold.
The bears are absolutely convinced that this market action cannot be sustained much longer. It has already made many high-profile strategists look quite foolish, but they are not backing down. They believe corporate earnings will slow quickly and the lagging impact of higher rates will hit the economy hard.
Seldom are the market battle lines as stark as they are now. The bulls are celebrating the very positive price action and are confident it will persist, and that the Fed will navigate economic conditions successfully. The bears tell us the market is ignoring all the obvious negatives, and it is only a matter of time before the short squeeze runs its course and the market rolls over.
That is where we at as the market awaits retail sales data and crude inventory data here on Wednesday. Later this week, there will be housing starts, the Producer Price Index and weekly unemployment claims. All this data will impact the market narrative, but until the price action weakens it won't matter much.
The bulls are enjoying a good run right now, but a sizable pullback is inevitable -- the great challenge is the timing of it.
We have minor weaknesses in the premarket but should see movement on retail sales numbers at 8.30 am ET.