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Investors now Dread Recession More than Inflation, Which is Why the Stock Market is in Freefall.

Stock market - Image from pixabay by stevepb
Stock market - Image from pixabay by stevepb Stock market - Image from pixabay by stevepb
Stock market - Image from pixabay by stevepb
Stock market - Image from pixabay by stevepb Stock market - Image from pixabay by stevepb

A stock market paradox, in which negative economic news is interpreted as positive for stocks, may have reached its conclusion. If that’s the case, stock investors should anticipate bad news to be terrible news going into the new year, and there might be enough of it.

 So why would excellent news be unfavorable in the first place? The majority of 2022 has been spent by investors focusing on the Federal Reserve and its rapid series of large interest rate increases meant to contain inflation. As a result of economic news suggesting weaker growth and less fuel for inflation, stocks may gain on the expectation that the Fed may start to decrease the inflation rate or consider future rate reduction.

What has thus changed? A lower-than-anticipated November consumer price index figure was recorded over the last week. Investors are growing more confident that inflation likely peaked in June at a level above 9%, a level not seen in about four decades, even though prices are still climbing by more than 7% yearly.

However, the Federal Reserve and other significant central banks made it clear they want to keep raising rates through 2023, albeit at a slower rate and perhaps for a longer period than investors had anticipated. This is fueling worries that a recession is coming sooner rather than later.

According to Jim Baird, chief investment officer at Plante Moran Financial Advisors, the markets are acting as though the worst of the inflation panic is behind us and that a recession is imminent.

According to Baird in a phone interview, manufacturing data from Wednesday and a weaker-than-anticipated retail sales number from Thursday supported that opinion.

According to Baird, markets are “likely headed back to a period where bad news is bad news,” not because rates will worry investors as much as earnings growth will.

A ‘reverse Tepper trade.’

Tepper predicted a “win/win outcome,” but despite his foresight, Lerner stated in a letter on Friday that the “reverse Tepper trade” is turning out to be a lose/lose scenario.

Stock market - Image from pixabay by stevepb
Stock market – Image from pixabay by stevepb

 According to Tepper, the economy would either improve, which would boost stock prices and asset prices. If the economy weakened and the Fed intervened to support the market, asset prices would benefit.

According to Lerner, the current situation would result in a weaker economy, reducing corporate earnings and putting pressure on asset values while also curbing inflation. Alternately, the Fed and other central banks continue to tighten policy while testing asset prices, ensuring that the economy and inflation stay strong.

Investors may have a headwind in either scenario. There is a third option, referred to as a “soft landing,” where inflation decreases and the economy avoids a recession. It’s feasible,” Lerner wrote, but he added that the chances of a smooth landing are dwindling.

On Thursday, retail sales for November revealed a 0.6% reduction, beating expectations for a 0.3% decline and representing the largest decline in nearly a year. Additionally, the manufacturing index from the Philadelphia Fed increased but remained negative, falling short of predictions, while the Empire State index from the New York Fed decreased.

After the Fed raised interest rates by half a percentage point the previous day, stocks experienced a steep decline after initially posting modest losses. The S&P 500 SPX, -1.11%, registered a 2.1% weekly loss on Friday, while the Dow Jones Industrial Average DJIA, -0.85%, lost 1.7%, and the Nasdaq Composite COMP, -0.97%, down 2.7%. Equities continued to fall on Thursday.

Economic data will have a greater impact on stocks as we approach 2023 because the data will provide the answer to a crucial question: How severe will the economic recession be? As we start the new year, the fundamental concern is growth and the potential harm from a slowing economy, according to Tom Essaye, founder of Sevens Report Research. With the Fed on relatively policy “auto-pilot” (further raises to start 2023), the critical question is now.

Recession watch

Nobody can predict with absolute confidence whether or not there will be a recession in 2023, but it seems beyond doubt that corporate profitability will be squeezed, which will be a major market driver, according to Plante Moran’s Baird. Therefore, earnings may present significant volatility in the upcoming year.

For 2023, he predicted, “profits and recession risk will be the story, as opposed to inflation and rates in 2022.”

According to him, the climate is no longer favorable for high-growth, high-risk stocks, but it may be favorable for value-oriented firms and small caps due to cyclical considerations.

According to Trust’s Lerner, “we continue our overweight in fixed income, where we are focused on good quality bonds, and a relative underweight in equities,” until the preponderance of the evidence changes.

Truist has a value bias when it comes to stocks and prefers the U.S. He believes there are “greater opportunities below the market’s surface” in the equal-weighted S&P 500, which serves as a proxy for the typical stock.

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