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Investors now dread recession more than inflation


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. 

First, then, why would good news be unfavorable? Investors have spent most of 2022 concentrating on the Federal Reserve and its swift run of significant rate hikes intended to control inflation. Stocks may rise on the belief that the Fed may start to moderate the pace of inflation or perhaps start to consider future rate reduction as a result of economic news pointing to slower growth and less fuel for inflation

On the other hand, positive economic news may be detrimental to stock prices. 

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% year over year. 

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 time 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, markets are acting as though the worst of the inflation panic is behind us and that a recession is already 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. 

called a "reverse Tepper trade" 

Keith Lerner, co-chief investment officer at Trust, asserted that a mirror version of the conditions that led to the September 2010 "Tepper trade," named after hedge fund tycoon David Tepper, may be developing. 

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. 

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

Investors may have a headwind in either scenario. To be fair, 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. 

As we approach 2023, economic data will have a greater impact on stock prices because it will provide the answer to a crucial question: How severe will the economic slowdown be? The key question as we start the new year is growth and the potential harm from slowing growth, said Tom Essaye, founder of Sevens Report Research, in a note on Friday. "With the Fed on relative policy 'auto pilot' (more hikes to start 2023) the key now is growth, and the potential damage from slowing growth," he added. 


Watch the recession

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 a significant source of 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.

Trust 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.

The November index of leading economic indicators and a revised assessment of third-quarter gross domestic product are among the highlights of the upcoming week's economic schedule. The Federal Reserve's preferred inflation gauge and statistics on November personal consumption and spending are scheduled for release on Friday.

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