The Goldilocks economic scenario that the bulls have promoted since the start of 2022 went out the window this week.
Not only have interest rates been moving steadily higher for a few weeks now, but the economic data suggests that we may see a half-percentage point rate hike at the next Fed meeting in March. Inflation is too hot, and there are no signs of major economic cooling, especially in the labor market.
The bulls did a nice job of fighting the Fed for a while, but lost the war this week. The indexes turned down under the weight of upward revisions of inflation news for the fourth quarter and higher-than-expected inflation in the month of January.
The indexes turned down a little over a week ago and then gained downside momentum all week. The bulls no longer had shorts to squeeze or poorly positioned longs to provide support. The S&P 500 took out its 50-day moving average support, and all the indices are now in a precarious position.
The primary question at this point is whether the indexes can find some support. The problem is that the market has not fully priced in higher interest rates and a hawkish Fed yet. The market had a big run when Fed Chair Jerome Powell used the word "disinflation," and now we appear to have accelerating inflation.
The market now has the highest expectations for interest rates since the Fed started tightening, yet the market is well above the lows it hit back in October. That isn't totally illogical, but it is hard to imagine a scenario where the indexes keep climbing while inflation and interest rates are rising.
I don't want to sound too gloomy, but there is a very high risk of more downside. The good news is that many individual stocks have already sold off far more than the indices. About 1,700 stocks are down 50% or more from their highs, while the indexes are not even close to that level. There are some great values out there already, and these names may not sink that much more even if the market does continue to trend down.
Have a great weekend. I'll see you on Monday.