The market was pounded on Monday as support levels fell, the number of new 12-month lows piled up and the S&P 500 hit a technical bear market on a closing basis.
The primary catalyst for the destruction is inflationary fears that are driving bond yields higher and pushing the Fed to raise interest rates aggressively. There are now increased expectations that the Fed will raise rates by three-quarters of a point at its policy meeting on Wednesday.
The market is grappling with the danger that aggressive interest rate hikes will slow growth and push the economy into a recession. Higher interest rates slow business investment and cool off demand for things such as energy and commodities, but they can't fix supply issues, which may keep inflation sticky to the upside.
In bear markets in 2020, 2008-2009 and 2001, the market had a dovish Fed that was cutting interest rates. This created additional liquidity and helped bolster the demand for stocks.
The current situation is the opposite. The Fed is withdrawing liquidity not only with higher interest rates but with quantitative tightening. The economy is still strong, with the labor market doing very well, but there are growing signs of slowing. If the job market weakens but inflation stays elevated, then it will create a real problem for the Fed.
The market is now struggling to discount this very difficult economic situation. Have stocks fallen enough to price in higher interest rates and the potential for a recession? It currently is not acting like that is the case, but we need to watch price action and see if stocks can stop going down on negative headlines.
Some market participants hope that an aggressive hike of 0.75% or even 1% by the Fed on Wednesday will provide some comfort that the Fed is no longer behind the curve and is starting to take control of the inflation issue. The problem is that the economic fallout of this sort of hike is highly uncertain, and a recession could occur sooner rather than later.
My game plan remains essentially the same. Stay patient, don't try to predict a market bottom, wait for better price action, and move incrementally when I do make buys.
We have a little bounce action in the early going, but the action is all about positioning for Wednesday's Fed decision.