Five Rate hikes later, with more expected. What next? 

Based on the current bear market rally many investors have clung to the idea that the Fed will pivot away from or at least pause interest rate hikes.

The problem with this line of thinking is that we are experiencing unprecedented times where the Fed is increasing interest rates into a bear market instead of decreasing interest rates as seen in previous bear markets. Have you ever seen the Fed tightening this aggressively into a major market decline?

The commonly held belief that the Fed will pivot is predicated on the idea that the Fed has done enough to flush inflation by removing the proverbial punchbowl. Has the Fed really done enough or are they so far behind the 8-ball that they are forced to pause and offer some relief before getting aggressive with interest rate hikes again?

In this Market Watch article, David Rosenberg president and chief economist and strategist of Toronto-based Rosenberg Research & Associates Inc says, "the Fed’s job is to take the punch bowl away as the party gets started, but this version of the Fed took the punch bowl away at 4 a.m.,” Rosenberg said, “when everybody was pissed drunk."

Additionally, the Fed is focused on indicators like CPI and the unemployment rates which are lagging indicators and they have told us in their forecast that they are willing to do whatever it takes to slay the inflationary dragon.

They are focused on getting prices down with a target of 2% inflation. They seem quite prepared to push us into an economic recession. What do we know about recessions? They destroy inflation and they trigger bear markets in equities and residential real estate. Does the Fed really have this thing under control?

During the 2007-2009 financial crisis, Ben Bernanke thought the subprime problems were going to stay contained.

Alan Greenspan thought at the beginning of 2001 that we were just in an inventory recession.

In a recessionary bear market, historically 83.5% of the previous bull market gets reversed.

So what is the difference between a soft-landing and a hard-landing bear market? In this Market Watch article, Rosenberg explains that in a soft-landing bear market, you reverse 40% of the previous bull market. However, in a hard-landing recessionary bear market, you reverse 83.5% of the previous bull market. The reason for this is that you get multiple contractions that also coincide with an earnings recession.

We've seen the start of a hit to earnings with recent reports from big tech but this is likely just the beginning of a potential 20% drop.

If you believe we will avoid a recession, then perhaps the bottom is already in.

Consider this though. This most current bull market doubled in less than 2-years and almost all of that was because of what the fed was doing and not because we had a massive earnings cycle. It was because the Fed pushed interest rates to near zero and double its balance sheet.

Now let's consider when the market will typically bottom. Rosenberg says not to focus on the S&P 500 level but when markets bottom. When does a market bottom? Historically, in a recession, markets bottom 70% of the way into a recession and 70% of the way into the Fed easing cycle (not tightening).

It’s likely the Fed will pause the rate hikes. But a pause is not a pivot.

Consider 2007. The Fed started cutting rates in September 2007 and the market topped that day. Did you want to buy into that rally?

The lows didn't actually occur until March of 2009, close to the last Fed rate cut.

If the Fed does pause, it may just be a knee-jerk rally.

As you can see from this most current rally based purely on speculation that if the Fed does decide to pause (a pause is not a pivot), then a rally should be expected.

The problem is that during a recession, you get earnings downgrades.

Even if the Fed pauses, it will be a knee-jerk rally because the lows won't come in until the Fed is finished with interest rate drops (not hikes).

Currently, the Fed is expected to hike 0.75% followed by subsequent rate hikes. Even if the hikes are slower, we are still a long way away from interest rate drops.

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