Our StormGuard-Armor (bull-bear) indicator is primarily driven by three distinctive market indicators, all of which are firmly negative. The depth and duration of the market’s loss YTD puts it in the category of a “prolonged bear market,” which means that it is much more serious than a moderate correction. The Fed is purposely driving the economy into recession to both cool the economy and bring down inflation. To do this, the Fed (1) is raising interest rates aggressively and (2) has stopped increasing the money supply by $1T/year and started decreasing the money supply by $1T/year – a $2T/year contraction from a year ago. The Fed was late to get started but is now determined to prevail against inflation with its aggressive policy. Slowing the economy inherently means that business revenues will drop, earnings will shrink, and stock prices will follow suit. Keep in mind that bear markets generally have a few rallies on the way down – they're often called bear traps for a reason. Finally, the Fed isn’t even halfway done, and it takes months for its policies to affect the economy. The old adage of “Don’t fight the Fed” is sage advice!. 

Mark Twain famously said "History doesn't repeat itself, but it often rhymes." The YTD S&P500 chart (right) appears very similar in character to the start of both the 2001 and 2008 bear markets (below). Strong bear market rallies after about 7 months only marked the start of a further 41% decline in 2001-2002 and a further 52% decline in 2008-2009. While no particular outcome can be guaranteed, a rhyme with history seems more likely than not.

  

                   Here's What Happened Next in 2001                                  Here's What Happened Next in 2008
   

The inverted yield curve (10yr - 2yr, below) is generally accepted as the most reliable indicator of a pending recession. As of August 8th, the indicator is at -0.44% and continuing to sink. Generally, this indicator stops declining when the Fed stops raising rates. Currently, the Fed is only about halfway to its targeted rate, which it aggressively plans to reach by December.
 

While P/E ratios have already substantially declined YTD, future earnings estimates do not yet reflect the impact of the pending recession. While energy prices have stopped rising in the past few weeks, it is expected that the onset of winter will strongly re-ignite energy prices as Europe struggles to find sufficient fuel for heating and power generation, given the disruption of Russian supplies. As tighter energy supplies push prices and inflation higher, the Fed will be further pressed to aggressively control inflation. Since the Fed has no way to produce more energy, its only available tool to reduce energy price inflation is to reduce energy demand by inducing a recession.