The December CPI report came in at 6.5%, with inflation having declined from 7.1% in November. Lower inflation expectations have boosted investor sentiment, causing stocks to rally in the New Year. This week, however, the S&P 500 Index has retreated and is trading under its long-term moving average, a delineator of trend.
History has taught us that during a bear market, the stock market does not fall in a straight line. Instead, it chops along with a downward trend giving investors intermittent periods of hope. The graph below reflects the bear market between 2000 and 2003.
S&P 500 Index (SPX) 2000-2003 daily chart
It is very difficult to get a sustained bull run when the Fed is determined to keep interest rates elevated as various FOMC members have signaled this week. Some Fed officials are considering a 0.25% increase in the first meeting of the year instead of 0.5%. Even though the increment pace may be reduced, the Fed will still likely reach its terminal rate of over 5% in a longer time frame unless something breaks in the interim. More importantly, Fed officials see their 2% inflation goal reached only by 2025.
Elevated rates are likely to remain longer than the market anticipates, which will continue to slow the economy. A clear message from the Fed is that they do not want to repeat the mistakes of the 1970s, where the Fed lowered interest rates too soon only to see inflation surge in a successive wave.
In addition, Microsoft’s announcement of 10,000 layoffs will not be the last of companies reducing headcounts. Moreover, companies with debt maturing this year will be hurt by significantly higher rates eating away at profits. Surging bankruptcies are a real possibility across several industries as corporate earnings take a hit. Fed Chair Powell said the soft-landing window has shrunk, and with the probability of a global recession increasing, 2023 is shaping up to be another challenging year.