It was inevitable that market concerns would eventually shift from inflation to a possible recession. Just a little over a week ago, we heard the bullish narrative that the market could handle elevated inflation and higher interest rates, because the economy would stay strong.
That narrative totally changed in the matter of a few days as two bank failures did the Fed's job for it and made inflationary data irrelevant. The concern now is how the financial system will impact the economy rather than the other way around.
As JPMorgan (JPM) strategists put it: The consumer price index "doesn't really matter. What happened over the last three days has done Powell's job for him. Credit creation at banks will collapse & the economy will slow. Inflation will taper off as a result. Any rally on the view that the Fed doesn't need to raise anymore is silly. If they don't raise, it's because of systemic risk to the banking system. Not a positive."
To help cement the fact that the primary market concern now is recession and not inflation is that a weaker-than-expected producer price index report was not celebrated this morning as anti-inflationary. It was feared as an indication that the economy had started on a downtrend to a recession.
The recession concerns were also given a boost by very weak action in oil. There is a significant technical breakdown in that sector today as it trades down to the level last seen over a year ago.
The question now is how much longer does this corrective action last. Many pundits were celebrating a new bull market back at the end of January, but it is clear now that it was just a bear market rally. Bear market rallies always convince people that the bottom has been seen.
Most notable right now is that there is a very big divergence between small caps and financials on one side and the big-cap technology sector. Small caps and speculative groups like biotechnology have been leading indicators for years, and they are leading to the downside again.
The Russel 2000 small cap index and its exchange-traded fund (IWM) is close to breaking its December support, and that would lead to a retest of the October lows, which is the current bear market lows. The financials are not far behind, but other indices, like the S&P 500, are not even close to testing the December lows at this point.
The current selling pressure is highly correlated, because it is macro-driven. It comes from the top down, and that means indexes are sold, and there is little stock picking. This leads to very poor breadth. Overall breadth is about 1,450 gainers to 6,550 decliners, but for the Russell 2000, breadth is much worse at around 200 gainers to 1,700 decliners.
The good news is that this action continues to create some very inefficient pricing in many stocks. That doesn't matter right now, but there will be a point when stock picking returns to favor, and that is when we will need to move fast and put money to work. Work on those shopping lists and be ready but stay patient.