Recession risk remains very high. We believe that US GDP needs to slow to 1% to push up the employment rate in order to slow wage growth sufficiently. This requires a 3.5% to 4% Fed funds rate which, in turn, causes the yield curve to invert in Q4 (leading to a ‘soft’ hard landing in 2H 23). When overall commodity prices have risen this rapidly, recessions have tended to follow. The policy response to slower growth is likely to be much more reactive than normal because of DM inflation, DM fiscal positions and excess leverage in China. A bear market can occur up to 13 months ahead of a recession. 

No upside on our fair value models. The ERP is 4.9%, and the warranted value has risen to 5.5%. Up till February, for the vast majority of the bull run since 2009 the ERP had pointed to clear upside not downside. Our P/E model is also only close to fair value. 

Earnings risk remains high. Earnings revisions have started to fall and 71% of the time when this happens, markets fall over the next quarter. Current PMIs imply significant further downside to revisions. We see clear risk of negative EPS in 2023. We think nominal US GDP of 3% to 4% is required to bring US inflation under control, and sub-3% nominal GDP causes EPS to fall. Profit margins and share of GDP have started to fall from an all-time high and require core PPI of 6.5%+, but the Fed will likely fight this. Half of RoE improvement has come from rates and tax, and now both are reversing.

 Credit flashing caution. When IG spreads are above 145bp (where we are today), equities tend to fall on a year-on-year basis. Credit spreads are still far removed from recession levels. 

Near bear market misses need a catalyst. On four occasions in the past 30 years, markets have bottomed after a c19.5% decline from their peak (=3860 on the S&P 500) but, on 3 occasions the Fed eased - we can’t see that happening this time around.

 Most NASDAQ bear markets lead an S&P bear market (by c5 months) and S&P bear markets on average last 12 with a decline of 31% (39% if no recession).

 No Fed put; it now seems more of a Fed call exists. 

Only sentiment is highly depressed on our tactical indicators. This is at normal buy signals though that said this does not appear to be fully reflected in household positioning or flows (i.e. fully invested bears!), and risk appetite is only modestly depressed.