The S&P 500 (SPY) has been retreating to a trading range between 4,000 and 4,200 over the past month. However, the bulls have taken 3 consecutive hits against them which may indicate a looming downward breakout. Let’s examine the growing evidence that the bears are likely to come to bat in the coming weeks and what this means for our trading plans. Read on for more.
Let’s set the scene right.
Before February 1stSt Fed announcement I shared 4 possible outcomes for the market next. Unfortunately, we have moved on to the least pleasant of these scenarios which I have described as follows:
“Scenario 4: Dazed & Confused
Here the Fed is giving mixed signals. Still hawkish for too long to save face given previous statements. And yet tip their hat a little for deflating inflation.
This gray area leads to a trading range until investors have more data in hand. I suspect 4,000 is the low end with 4,200 on the high end. This comes hand in hand with a ton of volatility as each new title forces investors to recalibrate their bull/bear odds.”
How accurate this has proven to be. Especially the part about every new title that makes people rethink how bullish or bearish they want to be.
There have been 3 consecutive strikes against the bulls pushing more investors into the volatile camp. Not only the market decline in the last 2 sessions. But the clear Risk Off nature of their picks with the money going back to the more defensive groups (Healthcare, Utilities and Consumer Staples).
Let’s examine the context score to consider these 3 strikes and what it means for the evolving market outlook. (This next section came from this recent comment: Strike 3 for Investors ON Thursday?)
“… strike 1 against the bulls. This is a MUCH stronger than expected government employment situation report showing strong job gains. This sounds great on the surface until you realize that it came hand in hand with very persistent wage inflation.
That’s exactly what President Powell warned last Wednesday, and why the Fed will keep interest rates higher for longer than the market estimates. The bulls scoffed at the idea the first time. However, they were surprised to encounter this sticky inflation once again on Friday.
Powell then made it clear next Tuesday 7/2 at the Economic Forum that these jobs reports lead him to believe they may need to push rates higher…or keep them in place longer to reset inflation to the 2% target.
This extended aggression is a great STRIKE 1 against the bulls.
.. Strike 2 launched this Tuesday (2/14). I refer to the higher than expected report of the Consumer Price Index (CPI) which stands at +6.4% against expectations of 6.2%. This is obviously a long way from the Fed’s 2% target.
Even worse, month-on-month inflation was +0.5% which is 6% y-o-y… Unfortunately, this very high month-on-month confirms the Fed’s view that the long-term fight against inflation is far from over from the end.
The immediate reaction to that news sent shares down nearly 1% early Tuesday. However, surprisingly the bulls once again fought back in a near even finish.
These bulls keep seeing positive things that I’m not…maybe they’re smoking things that I’m not so good at.”
All of the above forms the table for the Producer Price Index (PPI) report of Thursday 2/16. Indeed, this turned out to be Strike 3 for the bulls as it was very hot leading to an immediate sell-off on Thursday and Friday.
Let me drive home why this is so aggressive.
The recent bull rally was based on the idea that inflation was falling faster than expected. That means the Fed was likely to end rate hikes earlier than announced, increasing the chances of a soft landing leading into the next bull market.
These 3 recent events are a serious blow against this crazy idea. With inflation still so high, it means the Fed will likely stick to its pledge to raise interest rates to 5% or more…and keep those restrictive policies in place until the end of the year.
When you consider how weak the economy is right now, combined with another 10+ months of hawkish policies, plus another 6-12 months of lagged economic impact in this hawkish regime, it’s a recipe that increases the chances of a recession.
Recession = lower corporate profits = lower stock prices
All of the above makes me raise the recession and market expectations to around 70-75% (from the previous 65%). The main thing holding me back from a higher possibility is that employment remains incredibly resilient.
Most of us think of a recession as a period of economic contraction. This is only half the story. The key ingredient is that a weakening economy leads to job losses and thus an increase in the unemployment rate.
It is this difficulty that helps signal a recession and explains why negative readings for GDP in the first half of 2022 were not labeled as such. So, with employment so strong at this stage of the rate hike game…then it’s still likely to never really get worse, causing a soft landing and the end of the bear market.
However, even on February 1stSt, President Powell was saying that their baseline forecast still calls for unemployment to exceed 4%. That’s not so bad. However, history shows that once the demons of unemployment are unleashed, it usually turns out to be much worse than expected.
This is due to this vicious cycle:
Job loss > lower income > lower spending > lower corporate profits > cost cutting
And yes, layoffs are a big part of this cost-cutting regime that pushes the rinse-and-repeat cycle into the above with ever weaker economic metrics…and ever greater job losses.
Let’s summarize it.
No one knows for sure what will happen in the end. We just have to keep reassessing the potential for a recession and its subsequent effects on stock prices.
The latest announcements increase the chances of a recession and thus bring the market. This explains the 2 day sell off with a significant shift to Risk Off positions.
The information at hand may be enough to push shares past 4,000 once again for the S&P 500 ( SPY )…and perhaps back below the all-important 200-day moving average at 3,943.
However, I suspect investors will need more evidence which will not be available until early March with the next release of the ISM Manufacturing, ISM Services and Government Employment Situation. Plus the next inflation readings.
I’m not saying that the bull argument that surged in popularity to start 2023 is dead. However, the logic of further bear market extension is becoming increasingly likely.
Keep that in mind when evaluating your current portfolio structure and whether a more defensive setup is needed.
What should I do next?
Discover my new “Stock trading schedule for 2023” cover:
- Why is 2023 a “Jekyll & Hyde” year for stocks
- How the Bear Market must come back with a vengeance
- 9 Trades for profit now
- 2 Trades with 100%+ upside potential as a new uptrend emerges
- And many more!
But now! Stock trading schedule for 2023 >
I wish you a world of investment success!
Steve Reitmeister…but everyone calls me Reity (pronounced “Right”)
CEO, StockNews.com and Editor, Reitmeister Total Return
Shares of SPY were trading at $407.26 per share on Friday afternoon, down $1.02 (-0.25%). Year-to-date, SPY has gained 6.49%, versus a % gain in the benchmark S&P 500 over the same period.
About the Author: Steve Reitmeister
Steve is better known to the StockNews audience as “Reity”. Not only is he the CEO of the company, but he also shares his 40 years of investment experience in the Reitmeister Total Return portfolio. Learn more about Reity’s background, along with links to his latest articles and stock picks.
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