Another mad, bad bear market rally?

The Fed is also sending mixed signals, Morgan Stanley.

The Fed’s tone is getting cautious about continuing to extrapolate higher rates. Additionally, with 4 x 75bp hikes locked in (assuming 75bp in November), and likely another 50/75 in December, we think the Fed will emphasize the idea of waiting to see the “long and variable lags” from rate hikes affecting the economy.

September minutes: Several participants noted that, particularly in the current highly uncertain global economic and financial environment, it would be important to calibrate the pace of further policy tightening with the aim of mitigating the risk of significant adverse effects on the economic outlook

Lael Brainard’s comments: In light of elevated global economic and financial uncertainty, moving forward deliberately and in a data-dependent manner will enable us to learn how economic activity, employment, and inflation a readjusting to cumulative tightening in order to inform our assessments of the path of the policy rate.

Neel Kashkari’s comments: I think a much more likely scenario is we will raise to some level north of 4%, maybe 4.5%,and then pause and sit there for an extended periodof time while the tightening we’ve already done works its way through the economy.

Esther George’s comments: While my expectation is that rates are going to have to move higher for a sustained period, I do see risks around moving too abruptly to this new higher level. Moving too fast can disrupt financial markets and the economy in a way that ultimately could be self-defeating,

And Nomura’s Charlie McElligott notes the similarity to the last rally in terms of earnings.

But here we go again into EPS:The “Q3 Earnings as the next (negative) ‘shoe to drop’ for Equities” thesis is again treading on thin-ice into the meat of earnings season next wk, where similar towhat we saw in Q2 EPS(which precipitated / “juiced” the Summer Stocks rally),Bank earnings from JPM, WFC and BAC are showing that the 1) US Consumer refuses to crack,with credit card delinquencies stuck near the lows and net charge-off rates declining to historic lows themselves, despite card spending increases;and simultaneously, 2) that inflation continues to act as a TAILWIND for Corp Earnings via pricing-power being exhibited (PEP avg prices +17% in Q3 vs Sales Volumes only -1%!),as said resilient Consumer continues to “make it work” and spend, digesting price increases

Perversely then in the “NOW,”we see high Inflation paired with Commods prices relatively softer off the highs is then leading to a virtuous “sweet spot” environment for Corporate marginexpansion

With Inflation where it is, US Nominal GDP is over 10%…so top line growth stays spicy, which in conjunction with Wage Growth at ATH and overall Employment remaining “hot” then continues this “Schrodinger’s Economy” tension:current dynamics show “still relatively strong economic conditions” (where anecdotally, Restaurants, Malls, Airports, Concerts remain “foaming at the mouth”)…but awkwardly then juxtaposed against those consensual “hard landing / recession” forwards in the market, as inflation gets stickier and expands into Services, while “lagged and variable” implications from the FCI tightening gradually bleeding the economy, causing the u-rate to move higher along with default rates

The current “average” Consumer is seemingly able to handle losses in their “securities portfolios / 401k accounts” in a vacuum (especially when those are quoted on mulit-year return basis, i.e. SPX+14% and NDX still +27% since start 2020!) when their Home values are still largely sitting near high, and most importantly, they remain employed, with recent wage increases to boot

But the future instability comes when “2 of the 3”…or “all 3” of the above factors begin working against the Consumer—i.e. that securities portfolio is getting beaten-up AND they lose their job at same time and / or their house Equity collapses—THEN the calculus changes…but that isn’t “now” just quite yet…

Even the very bearish Michael Wilson at Morgan Stanley is on board.

Last week’s infatuation with CPI/PPI may be a trap for the inflation bulls. The 200-WEEK moving average is a serious floor of support until companies fully confess or a recession officially arrives, both of which could take several more months and lead to a technical rally in the short term.

Technicals May Gain Upper Hand on Fundamentals….last week’s inflation reports did not disappoint those looking for confirmation inflation remains a problem. However, these data are some of the most backward looking economic series and tell us little about the future. In our view, inflation has already peaked and could fall rapidly next year as comparisons become very difficult and discounting returns. This would argue for lower back end rates, which could be supportive for stocks until the earnings are cut as we expect and/or a full blown recession arrives. A tradable tactical rally looks likely,as the 200-week moving average is strong technical support until the Ice sets in.

Earnings recessions are slow to play out… prior earnings recessions have taken 15 months to play out, on average. While it feels like this downward EPS revision cycle has been in process for a long time, we’re only about 3 months in from the early July peak in numbers. As we have written about extensively over the past 2 months, our top down leading earnings models are pointing to an acute and material earnings deceleration over the next 12 months. However, it typically takes time for bottom-up consensus expectations to reflect the top-down earnings risk. We’ve seen the market multiple discount the earnings downside somewhere between ~40-50% of the way through the EPS compression. Given the speed of this cycle, we think the duration of this earnings downdraft could be shorter than average. All in all,history points to the next 3-4 months as the window to fully discount the earnings recession.

If markets do run then the FCI easing will short-circuit it in due course. Inflation is still glued above 5% core: