The stock market has been strong since early October.  The S&P 500 rallied 6.5% in October and is up 2.5% so far in November (through November 28th).  Although this is likely a bear market rally, something has changed in investors’ minds.  In the short term, investors seem to be focused on what could go right, which includes the following list:

– Inflation drops faster than expected, allowing the Fed to slow rate increases and “pivot” earlier than previously expected.
– Earnings hold up well.  Although Q3 earnings were a disappointment, Q4 and 2023 earnings are forecast to be positive (+2.2% in Q4, +7.9% in 2023).
– Recession is priced in.  S. equity multiples have plunged and may already reflect a recessionary scenario.
– Supply chain problems continue to ease, lessening the pressures on future inflation.
– The war ends helping the global economy.
– We will enjoy the rally for as long as it lasts, but the typical bear market playbook tells us the bear is not over (see main section).

We seem to have seen the worst in inflation for this cycle. Our quick inflation summary:

was:  0-2% forever
recent peak:  Q2 8-9%
by year-end:  4-6% (annualized)
big question:  will the Fed pause at 4-6% inflation or insist on 2%?

Why is inflation declining?  There are a number of reasons including:

– Fed raising rates to slow economic growth
– significant slowing in money supply growth
– dollar strength
– lower commodity prices
– some let-up in supply chain disruption

Let there be no mistake about it.  Inflation may be the number one driver of stock prices in the short term.  The Fed is laser-focused on the inflation numbers.  It looks like most Fed governors are looking to slow the rate of growth of future rate increases (no more 75 bp increases), but one Fed member, noted hawk James Bullard, stated that a terminal Fed funds rate needs to be as high as 7% (now 4%).  That would be enough to kill this rally and likely lead the market to lower lows.  Luckily, no other Fed governor is this hawkish.

We will continue to monitor inflation developments, especially since it has such a major bearing on whether the Fed can achieve a soft landing.  We are skeptical because the Fed started too late in this cycle, and rate increases have been so severe.  We remain in the camp that a recession is likely in 2023.




Bear markets are a process and often look similar from bear cycle to bear cycle.  This one is following a textbook progression which is one of the main reasons we don’t think it is over.  Here is a step-by-step process of a typical bear market.  Note the similarities to this cycle’s downturn.

What we have experienced so far…

  1. High inflation (peaked near 9%)
  2. Central Bank tightening
  3. Valuations under pressure (U.S. equity multiples have contracted dramatically)

Where we are now…

  1. Economy slows (our economy is starting to roll over)
  2. Downward earnings revisions (we started to see this in Q3 earnings announcements and guidance)


What to watch out for…

  1. Credit risks
  2. Liquidity risks

Once a recession hits, we need to worry about worst-case scenarios.

Fed actions will be the most important determinant of how fast we go down the bear market path.

The stock market has rallied since October and markets have been focusing on positives – what could go right – but the market fundamentals still look negative to us.  We suspect we are having another bear market rally.  We remain cautious.  Our equity portfolios remain neutral/defensive.  It is premature to add beta (risk) to portfolios, although that day is coming sometime in the first half of 2023, in our view.