Hey, are you enjoying the early gains for the 2023 stock market? Me too. Unfortunately, this appears to be a mirage with the S&P 500 (SPY) poised to move lower… and likely to make new lows in the coming months. Why is that? Read on below for the answer.
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The market is hot out of the gate to start the new year. Perhaps too hot because the applause for softer inflation muffled the rumor that these lower prices were the result of serious recession red flags.
I feel this may be the last gas for bulls and the bears are about to take the wheel again.
Why?
That will be the focus of today’s commentary…
Market Commentary
The new year always brings fresh optimism. That alone could explain the +4.2% for the S&P 500 (SPY) to start the year.
On the face of it, bulls may point to exciting news that inflation continues to fall. That was certainly the headline, especially after the 1/12 CPI report. Let’s dig deeper into that…
At this stage, month after month is more important than year after year. That’s because most of the inflationary pain happened many months ago, especially in the spring of 2022. That makes inflation seem high year after year… but the month after month tells you the true current rate.
On that note, we see core inflation rising +0.3% monthly, pointing to +3.6% year-over-year, which is well below historical levels…but still well above the Fed’s target of 2%.
More specific “sticky inflation‘ is still a problem. This report shows a +0.8% increase in shelter (housing) prices, which equates to almost 10% per year. Way too hot.
Last week, further wage inflation was reported at +4.6% yoy with a slight trend slowdown to +0.3% month on month (+3.6%) pa.
The sum of this information says that the Fed will not change its tone. So given what the Fed has said in the past about keeping rates high for long… and repeating that mantra over and over, including this past week…st Fed announcement as another cold shower for bulls.
Now let’s look at what’s causing the lower inflation. That’s 9 consecutive months of restrictive Fed policies finally working. However, that is the view over the left shoulder. If you look over the right shoulder, you can see that this has come at the expense of an economy on the brink of recession.
- 48.4 ISM production at 1/4 with 45.2 new orders (reads recession)
- 49.6 ISM services at 6/1 with 45.2 new orders (reads recession)
- 89.8 NFIB Business Optimism Index at 1/10 (lower value than during Covid…read recession)
- 1/13 Earnings season kicks off with 2 of the 4 major banks fouling the bed. JPM warns they are bracing for a recession.
Note that the US hasn’t had an inflation-induced recession since the 1980s, so investors are a little disgruntled about how to handle this rare environment. This means they are far too interested in looking at inflation data and predicting the likely response from the Fed as opposed to what they should be doing. That is to follow the health of the economy as their guide to being bullish or bearish.
If a recession is on its way, it will lead to lower corporate earnings (typically a 20% drop in earnings per share) and will lead to lower stock prices given what investors are willing to pay for that weakened earnings profile. Therefore, it is very difficult to be bullish right now.
Let’s continue with a discussion of earnings season. The previous quarter was probably one of the worst in years as earnings expectations for the coming quarters were slashed. Another round of that would be detrimental to stock prices.
This means that we have to keep a close eye on earnings developments. Specifically, the change in estimates for the future and if current expectations for a 7% decline in Q1 revenues darken or brighten from here. That will have market-moving consequences.
Again, the average recession leads to a 20% drop in EPS expectations. That is certainly not factored into share prices at this point. All the more reason to keep a closer eye on earnings estimates. The early banking results herald more pain on the way.
Now let’s turn to price action. Bulls have already had some pretty impressive runs in the middle of the bear market in recent years, but were thwarted at the moment of truth. See the S&P 500 one-year chart below.
Make sure to focus on the 200-day moving average (red line), which puts an end to bullish advances. Both mid-August and late November and maybe again here in January.
Note that as of Friday’s close, the S&P is at 3,999, while the 200-day moving average is at 3,981. It sounds frightening that we are currently above that mark. But before you join the bull party, please listen to me.
This is VERY typical behavior at the end of a bull run. Especially one that ends on a Friday.
Here we had premarket futures down 1% after some very bad bank earnings reports. But even then I knew the stock would end the day higher at 4,000.
Why?
Call it pattern recognition as I’ve seen it before. That’s where the bulls have just enough energy to strike back one more time and set up a cliffhanger-type moment: Shall we break higher?…Will the bear be on the hunt again? Tune in next week for the thrilling conclusion.
Unfortunately, Friday’s action is kind of like sprinting to the tape at the end of a marathon…just not much energy to run again soon. This creates a high probability of downward action down the road. However, I admit that anything is possible and that the bulls can indeed have a few more laughs.
But now that the recession clouds are darkening and the earnings season is off to a slow start and the Fed is likely to be aggressive “a long time” mantra at the Feb 1 meeting…then I suspect we’ll soon be at the end of this bullish run with more downside to come.
Even if stocks are above the 200-day moving average right now, I’d have a hard time joining that party until the Fed’s announcement at 1/2 where they’ll likely start pouring cold water on the bulls again. casting.
What to do now?
Check out my brand new presentation: “Stock market outlook for 2023” covering:
- Why 2023 a “Jekyll & Hyde” year for shares
- 5 warnings indicate the bear will return in early 2023
- 8 trades to make a profit on the way down
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- 2 Trades with 100%+ upside potential as new bull emerges
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Wishing you a world of investment success!
Steve Reitmeister…but everyone calls me Reity (pronounced “Righty”)
CEO, Stock News Network and Editor, Reitmeister Total Return
SPY shares rose $0.08 (+0.02%) in after-hours trading on Friday. Year-to-date, SPY has gained 4.20% versus a percentage increase of the benchmark S&P 500 index 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 investing 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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