Stock market continues to recover from the ugly January actions, with the S&P500 going for a 3 straight weeks of gains (compared between week opening and closing). We're only ~5% off from all-time high on the S&P500, 3% for the Dow Jones Industrial Average and about 10% for the Nasdaq Composite. Below is the chart of the S&P500 (represented by the SPDR S&P500 ETF  - ticker symbol SPY), we annotated some key levels to watch and then discuss further our thoughts.

January 2022 Consumer Price Index - 8:30 AM Today

We're pressing against some very key levels (particularly $460 on the SPY or $4600 on the S&P500 Index) that we were able to hold throughout November-December of last year. We believe the key inflation report - Consumer Price Index for January 2022 - coming out at 8:30 AM today will decide whether we can break this resistance or not. 

The CPI is expected to show headline inflation at the highest pace since 1982, rising 0.4% month-over-month or 7.2% year-over-year. Remember, CPI is one key indicator the Federal Reserve uses to gauge inflation, one of two key missions for the Fed to control. The Fed wants inflation to be at 2% over some time, and obviously 7.2% is very hot. What they would have to do to control this is to tighten monetary policies.

What if we get a higher-than-expected inflation number? This would be bad for stocks, as it would argue for the Feds to raise rates more aggressively. The market is currently pricing in about 5 x 0.25% interest rate hikes in 2022, or between 1.25% - 1.75% in Feds Funds Rate by the end of this year. A hotter-than-anticipated inflation read would push this probability higher, pricing in an even more hawkish Federal Reserve, which will undoubtedly take a toll on stocks, especially with them being only a few percentage points away from record high.

What if we get a lower-than-expected inflation number? We believe this will be good for stocks. It would show that inflation is indeed peaking/ on the decline as the Feds and market bulls anticipated, arguing for the Feds to be more nimble in their tightening process. If this is the case, we're likely going to break the technical resistance and press against record highs (although not quite breaking record highs just yet).

So how should you play this?

You shouldn't, and that's because at this price level (only a few percentage points off from all-time high), the risk-reward is not as good. In terms of upside risk for this stock market (catalysts for the market to go up), we think the only one that exists is inflation peaking (again, that would argue for the Fed to be less hawkish). But there are many downside risks: inflation not peaking, Ukraine-Russia tension, China-Taiwan tension, unexpected Covid variants, economic recessions. If we were at the depth of a 15 - 25% sell-off, we'd be willing to take the risks because at that point, the risks have been priced in. However, at these higher levels, the risks come back into play. 

The bottom line, as our title suggests, don't be bulled up too quickly. Remember the upside and downside risks that we posed here, and invest with discipline.