The forecast of a weaker economy became a clear consensus when the Fed finally committed itself to a rate hiking policy last March to crush inflation down to 2%. The debate ever since has been around the degree of GDP slowing and coincident earnings per share coinciding with either slow growth or a deep recession.

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The economic outcomes matter for corporate earnings of stocks and valuation multiples reflecting future expectations. Naysayers point to proxies such as negative yield curves (short term yields above long term), but these fail to recognize the current unique global labor conditions and the other worldly level of excess stimulus needing to be drained from the financial system. A more recent data point conjured up to support preconceived notions of doom and gloom has been the Coincident Indicators from individual states. This is not necessarily an accurate measure of economic conditions in each state, but historically when half of the States exhibit an arbitrary degree of negative growth, then a nationwide recession is underway. At year end 2022 there was a data blip that flashed an overall recession signal of 26 states in contraction. However, since then, this measure was shown to fall short of waving a red flag, to the chagrin of the Bear majority growling from the sidelines. The weighting of these coincident indicators relies too heavily upon manufacturing instead of services and employment, 

which remains strong in virtually all states. It’s difficult to have a serious recession with record low unemployment and a lack of financial stress.

For a typical example of our “this time is different” mantra, we point to Kansas as a State deemed to be contracting. Businesses and individuals are not defaulting on loans and everyone that wants a job in Kansas has one. It takes a very biased view to classify this as a recessionary condition. When companies feel the pain, they will send their workers to the unemployment lines. When consumers are out of work or failing to pay back their loans, then a recession becomes a worry and stocks will be revalued to new Bear market lows. The 2022 Bear market was about lowering growth expectations. Any new lows in the stock market from here would reflect a potentially serious recession with much higher unemployment. 

The valuation low when the S&P 500 Index tested 3500 in October was pricing a mild economic recession and modest earnings contraction year over year. The downward earnings nadir in each cycle typically marks the end of Bear markets in stocks and in the economy two to three quarters afterwards. There can certainly be another major leg lower in stocks, as the majority seem to believe, but that would reflect a consensus that a major recession has begun and unemployment is surging. While the Bears are in pause mode, the Bull market is unlikely ready for takeoff into a brand-new expansion cycle. For the Bears we need labor conditions and credit quality to deteriorate markedly before we would expect new market lows. In Q4 of 2022, the rate of change in downward earnings revisions reached major Bear market low territory. There could be more to come, but historically the risk levels begin to fall soon.

On the technical outlook we will highlight the recent focus on the Volatility Index or VIX. This index is a measure of put and call option premium reflecting a perceived level of risk or price movement over time. VIX tends to rise when the stock market falls and remains low while stocks are rising. It’s most reliable when the index climbs to extremes above 35, signaling that the timing of a stock market bottom is nearby. For market tops when VIX is falling, the usefulness declines as a VIX low is finite and can linger at various low levels. During the past year VIX has been quite consistent in forecasting short-term peaks when falling to 20 or lower. At 18 on the VIX today it may appear another top has arrived. This could be true, but it’s risky to assume this easy relationship will continue if we shift away from the persistent Bear phase of new market lows every few months. As seen here, VIX was quite inaccurate at projecting tops in 2021.

The phalanx of investment banks and forecasters have formed a tight outlook around a mild recession and one more set of new lows in equities in the first half of 2023. While we can adjust to evolving conditions, our outlook is for a Traders market. The stock market bottomed 3 months ago and while the current rally is reaching some thin air for the January, we expect more oscillation between testing Bear market support and Bull market resistance levels this quarter. Readers know we expected the Santa Claus rally failure in December, but forecasted a rally phase into the 2nd or 3d week of January – which we have continued to outline graphically. After a peak this next week and a late January pullback, there could be one more test of the highs before a more serious correction ignites into the ides of March (SPX). 

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