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Hope you are all doing well. The market continued its relentless decline this week.  Although losses weren’t as steep as those in the previous two weeks, the major U.S. stock indexes fell nearly 3%, declining for the sixth time in the past seven weeks. The Dow on Monday joined the S&P 500 and the NASDAQ in bear market territory, as the Dow declined more than 20% from its level of early January.  The S&P 500 is down about 23% for the year and is now pricing in a 79% chance of recession.  We have been hearing about this potential end of days recession for months now from the glass half empty television pundits.   I see it as a glass half full. Yes, a recession could be in the cards with the Fed aggressively tightening but it will likely be a slight or shallow recession.  Nothing now indicates a deep or prolonged recession.  The U.S. labor market continues to show resilience, the banking and financial system are structurally sound (unlike prior to the financial crisis in 2008), credit markets appear orderly albeit at higher rates and corporations are still turning a profit.  This week the whole sports world has been talking about properly recognizing concussions after the injury on Thursday to Tua Tagovailoa. I have broken down this week’s update using symptoms of a concussion.  I think if the market rids itself of these symptoms it will clear its concussion protocol and go higher.

Blurry vision

The outlook for inflation is hazy at best. It is evident that in order for the stock market to move higher inflation has to move lower. Inflation has been wreaking havoc on markets all year.   The Fed and central banks around the world now view it as the top priority.  The Fed has already indicated that it will continue to raise rates until it sees “clear and consistent” evidence that inflation is abating.   That probably means 3 or 4 months in a row where all inflation indicators are going lower and that just hasn’t happened yet.  This week we found out that despite the U.S. Federal Reserve’s efforts to contain inflation, the Personal Consumption Expenditure (PCE) inflation rose more than expected.  PCE is a monthly inflation metric that the Fed uses as its preferred gauge of price trend.  Excluding volatile food and energy, consumer prices rose 4.9% in August after dropping to an encouraging  4.7%  in July.   We will need a consistent non-blurry signal inflation is moving lower for the market to turn around.

Sensitivity to light and noise

The bond market continues to exhibit too much sensitivity to news events and global central bank comments and actions.  It was another unusually volatile week in the bond market. The yield surged as high as 3.99% on Tuesday to the highest level in 14 years. The next day, it tumbled to 3.71% before ending Friday’s trading at around 3.80%.  For the market to rebound bond yields need to stabilize and ultimately come down. A stable bond market supports financial markets, especially stocks as investors and companies could borrow at stable low rates. A stabilization in yields will likely indicate a potential pause in Fed rate hikes is on the horizon and would be great news for stocks.

Loss of balance

An ultra-strong dollar is good if you’re traveling overseas.  Not so good for the stability of markets because it causes a trade imbalance. U.S. companies that export goods or services are hurt by the stronger dollar, as it makes their products more expensive abroad. The U.S. dollar has been moving higher all year and is up 25% since early 2021 relative to other global currencies. The British pound at one point this week dropped to $1.03, the lowest dollar price for a British pound ever.  This move has been driven by several factors, including the relative rate moves by the Fed versus global central banks and the relative resilience of the U.S. economy. If the U.S. dollar stabilizes and ultimately moves lower, that probably will indicate an impending pause in the Federal Reserve rate-hiking cycle. It also would help reduce the trade deficit and ease financial conditions globally.

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