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Bear Market? Yes. Recession? Not So Fast.

Last Friday, we declared a bear market for the S&P 500. We based that on its intra-day low of 3810, marking an almost 21% decline from its high. From there it pushed higher to close the day at 3901, just shy of what has been deemed to be an “official” bear market. In the past we’ve adhered to conventional thinking that requires a close beyond the 20% threshold to earn that label. Given this year’s collapse of the NASDAQ to a level near a 30% decline, we’ll apply the “close only counts in horseshoes” approach and check the bear market box for this cycle. That opens the door for many to assume the market has priced in a recession as a foregone conclusion. We’re not there yet. There have been three occasions in the post-war period where bear markets occurred and recession was avoided. Last week mimicked 2011 where we saw an intra-day low for the S&P 500 mark a -21% decline. Ultimately, no recession followed. Given today’s unprecedented conditions and at this early stage of the shift in Fed policy, it’s too soon for us to check the Recession box.

The internals of Friday’s decline presented a divergence from trend in the on-balance volume and advance decline line. Those provided a glimpse of what could be the seeds of seller exhaustion and a subtle shift to buying selected issues with compelling risk/reward ratios attached. That could explain why this week we’ve seen the indexes churn higher on mixed economic data. The recent rally in bond prices and easing of yields, along with this week’s data could be taken as an early sign that peak inflation may be near and the Fed may not have to pursue the extended, worst-case scenario for interest rates as predicted by the stock market.

We’re at the point where bad news for segments of the economy are good news for the fight against inflation. As you might expect, tighter credit has created headwinds for housing with higher interest rates triggering a decline in mortgage applications and home sales. That, in turn, has weighed on the stock prices of home builders, the Financials, and construction related commodities. Forward-looking manufacturing expectations have weakened recently on soft new orders data. That, and lower prices in selected commodities indicate that the Fed’s tools in fighting inflation are having an effect.

Meanwhile, consumer spending has remained on a mildly positive trajectory for three consecutive quarters, that trend being confirmed by the robust Retail Sales data of the past quarter. With consumption representing 70% of GDP, that could prove to be a cushion for the “soft landing” the Fed seeks to craft. The FOMC meets next on June 15 where we expect another 50bp bump in the Fed Funds rate. That should come as no surprise to the market. Until then, we expect the current volatility to persist as more economic data is released, giving rise to speculation as to how that information will shape the Fed’s future policy actions. Stay tuned.

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