The road to year-end gains for stocks will be hammered by volatility as investors try 'sniffing out' a rollover in inflation and a Fed U-turn on rates

• Stocks powered higher this week after the October inflaton report but the path to year-end gains remains volatile, market analysts say.
• Inflation may have peaked but CPI at 7.7% is still well above the Fed's 2% target.

The sharpest jump in stocks in two years was sparked this week by a report of cooling inflation, though analysts say that while further equity gains could be in store this year, the Federal Reserve is unlikely to deliver the so-called pivot investors are longing for.

Investors embraced the Labor Department's report Thursday showing headline inflation edged down to 7.7% in October from a 40-year high of 8.2% in the prior month. Economists had widely expected a rate of 8%. Core inflation slowed to 6.3% from 6.6%. The figures ignited a rally that sent stocks to their best session since 2020. The Nasdaq Composite soared 7.4%, the S&P 500 gained 5.5%, and the Dow Jones Industrial Average sprang up nearly 1,200 points.

"I think that we're set up to rally into the end of the year, barring some major exogenous event. It won't be a straight-up rally. It's going to continue to be volatile, I would argue, probably through the first quarter," Nancy Tengler, chief investment officer and chief executive officer of Laffer Tengler Investments, told Insider.

"And then I think we're in good shape to take off because the valuations are not out of line with where we've been historically at comparable Fed funds rate levels," she said.

People covering short positions and outsized influence of trading algorithms appeared to have helped fuel Thursday's rally, Tengler said in taking a broader view of that day's run higher.

After the inflation report, investors began pricing in higher odds of the Federal Reserve stepping down the size of its next interest rate hike in December, to 50 basis points. The Federal Open Market Committee has raised rates by 75 basis points at its past four meetings, leaving the fed funds rate at a range of 3.75% to 4%.

The "market's been sniffing out a rollover in inflation," said Tengler, who said her shop estimated that inflation peaked in June when CPI hit a scorching 9.1% as food and energy prices jumped.

The economy appears to be four to five months into a lower inflation regime and forward-looking indications such as purchasing managers indexes suggest further softening in inflation, said Tengler. "I don't think we're going to get back to 2% anytime soon," she said about the Fed's target.

Another inflation report is due before the Fed's next meeting. November data will be released on December 13, the same day policymakers will begin their last two-day meeting of 2022.

"Inflation is nearly double what the fed funds rate … so I think there's still going to be some [rate] raises, more than people want or maybe smaller," Michael Landsberg, chief investment officer at Landsberg Bennett Private Wealth Management, told Insider. The firm has $1 billion in assets under management.

No pivot

"I don't think there's a [Fed] pivot anytime soon," he said. Whether the Fed hikes rates by 75 basis points for a fifth straight time in December or steps it down to 50 basis points will be data-dependent. The Fed, with more moves in the pipeline, could consider remaining aggressive in the face of continuous equity rallies, he said.

Thursday's rally allowed Wall Street's major indexes to narrow their year-to-date losses, with the Dow Jones Industrial Average down about 7% as of midday Friday.

Landsberg said the Dow could manage to swing into positive territory for the year but he sees the trend generally lower for stocks.

"Typically, you're not seeing 5%, 6% moves in indexes in bull markets. We're seeing a lot of volatility, some short covering here - one of the reasons things have been driven up so much," he said. "I'm looking at what's going to happen as we start to see more companies lay off people."

Layoff announcements have accelerated with news from Facebook parent Meta and Twitter arriving this week. In October, US-based employers in October announced 33,843 job cuts, a nearly two-year high, according to outplacement firm Challenge, Gray & Christmas.

"I predict we'll finish the year [in stocks] about where we were before this big rally," Tim Pagliara, chief investment officer at CapWealth, told Insider. The Tennessee-based wealth management firm oversees $1.2 billion in assets.

Pagliara said his projection applies to the S&P 500, the Dow industrials and the Nasdaq as investors will engage in tax-loss selling next month and, at the same time, will wait to see the makeup of Congress after mid-term election results are settled.

Meanwhile, core and headline inflation remain well above the Fed's comfort level, he said.

"If there's still work to be done with inflation then rates are still going to go higher. How high they have to go and how far this will be extended into next year really remains a question," Pagliara said. "So unless the Fed has redefined and will tolerate much higher inflation than the 2% target that they have, I don't think things will change much."