The early 2023 rally was always too good to be true. That’s because the myopic focus on moderating inflation needs to give way to a broader view of the looming recession which should have investors hitting the sell button in earnest once again. Not just a temporary pause like we saw Wednesday and Thursday.

We need to take a deeper dive on this conflict between investors focused on inflation data versus those looking at the overall economic picture. You know that I stand with the latter group which is why the bearish drum beat is only growing louder in my ears.

The standoff between bulls and bears will be the focus of this week’s discussion.

Market Commentary

The inflation vs. recession battle took center stage on Wednesday when 2 key economic reports were released simultaneously at 8:30am ET: Producer Price Index (PPI) and Retail Sales.

The much lower than expected PPI report got everyone’s attention out of the gate leading to a surge in stock prices over the key resistance level at 4,000 for the S&P 500 (SPY) The next thing you know the downward momentum starts and kept chiseling away all day long. This is how stocks sold off 2% from peak to valley ending the session at 3,928.

Those investors myopically focused on inflation were left scratching their heads.

Those who were focused on the red flags in the Retail Sales report knew darn well why stocks were heading lower. That being another nail in the recessionary coffin for the US economy.

To be clear, inflation is absolutely coming down at a quicker pace than most expected. This does mean that hawkish Fed policies are working. And they may pivot to dovish earlier than expected...but not for quite a while. That message was echoed once again on Friday by Fed Governor Waller when he said:

“...we still have a considerable way to go toward our 2 percent inflation goal, and I expect to support continued tightening of monetary policy”

HOWEVER, the real reason inflation is moderating is because we are now teetering on the edge of a recession. This came through loud and clear from recessionary signals from a myriad of January economic reports like:

• 48.4 ISM Manufacturing on 1/4 with 45.2 New Orders (reads recession)
• 49.6 ISM Services on 1/6 with 45.2 New Orders (reads recession)
• 89.8 NFIB Business Optimism Index on 1/10 (lower reading than during Covid...reads recession)
• -32.9 NY Empire State Manufacturing Index (lowest reading since May 2020 when the economy was in downright collapse).

And yes, the Retail Sales report that arrived side by side with the PPI report Wednesday morning bodes ill for the state of the consumer. The -1.1% month over month decline is all the more shocking when you realize we are talking about December retail sales...yes, the normally buoyant Christmas shopping season was underwater.

This is a very typical pattern for a recession induced by high inflation. Think about it this way...when you are afraid of rampant inflation, that means if you don’t buy now the price will be far too high in the future.

At first this creates impressive economic growth as demand is pulled forward (buy now). And then a cliff is created as buyers are tapped out with less to spend in the future. That contraction = recession. That cliff is likely what we saw in those week holiday shopping results as well as other early 2023 economic data.

Indeed, moderating inflation is good news in isolation. And it does likely say the Fed will not have to go as high with rates or keep them aloft as long.

On the other hand, please appreciate that this is all happening because we are in month 10 of this hawkish regime that is likely producing a recession that begets lower demand that begets lower prices.

So if it took 10 months to create this outcome, and we are sinking into recession, and the Fed has already said they would keep rates high for “a long time”. then we have to appreciate how long it will take for any pivot to dovish Fed policies to resurrect the economy.

Like end of the year...or 2024. And when you fully appreciate that picture of recession coming before recovery...it makes it all the harder to get truly 100% gung ho bullish at this time.

So does that mean now is the time to be ferociously bearish? Yes and no.

YES...this is the logical outcome from what I said above. Especially given the lessons of history where recessions are the leading cause of bear markets.

NO... is that the market can often have a mind of its own and take a different path. Especially true when computers do more of the heavy lifting than actual human investors. So fear and greed are not quite the same as historical patterns.

Long story short, I expect things to roll further bearish as more investors broaden their focus from just the inflation picture to the overall health of the economy. The more they read recession, and with it lower corporate earnings, the more likely stocks head lower from here.

That’s because the leading cause of bear markets is the state of the economy...where recession = bear market.

So keep your eyes firmly fixed on that economic picture to guide your investing decisions from here. The current clues point to more downside ahead. However, that may not fully take place until after the February 1st Fed announcement where Powell will once again remind bulls that he did not stutter when he said that rates will be high for a long time. And that long time is far from over.

What To Do Next?

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If you have been successful navigating the investment waters this past year, then please feel free to ignore.

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Wishing you a world of investment success!

Steve Reitmeister…but everyone calls me Reity (pronounced “Righty”)
CEO, StockNews.com and Editor, Reitmeister Total Return

SPY shares fell $0.13 (-0.03%) in after-hours trading Friday. Year-to-date, SPY has gained 3.52%, versus a % rise in the benchmark S&P 500 index during the same period.

Steve is better known to the StockNews audience as “Reity”. Not only is he the CEO of the firm, 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 most recent articles and stock picks.

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