Bears back in charge?

The S&P 500 (SPY) has been hovering between 4,000 and 4,200 for the past month. However, the bulls got 3 straight strikes against them, which could indicate an imminent breakout to the downside. Let's review the mounting evidence that the bears are likely to do battle in the coming weeks and what that means for our trading plans. Read below to learn more.

Let's set the scene properly.

Ahead of the Fed's February 1 announcement, I shared 4 possible outcomes for the market going forward. Unfortunately, we've settled on the least advisable of these scenarios which I've described as follows:

"Scenario 4: Dazed and Confused

This is where the Fed gives mixed signals. Still warmongering for a long time to save face given previous statements. And yet, take a little hat off to the moderation of inflation.

This gray area leads to a trading range until investors have more facts in hand. I suspect 4000 is the low end with 4200 at the high end. This comes with a ton of volatility as each new security forces investors to recalibrate up/down ratings."

As it turned out to be correct. Especially the part about every new headline making people rethink how bullish or bearish they want to be.

There were 3 consecutive strikes against the bulls pushing more investors into the bearish camp. Not just the market decline of the last 2 sessions. But the obvious Risk Off nature of their picks with money going to the more defensive groups (Healthcare, Utilities and Consumer Staples).

Let's take a look at the box score for these 3 warnings and what this means for the changing market outlook. (This following section was excerpted from this recent comment: Strike 3 for CE Investors on Thursday?)

"...hits 1 against the bulls. This is a MUCH stronger than expected government jobs report showing robust job gains. Sounds good on the surface until until you realize it went hand in hand with very persistent wage inflation.

This is precisely what Chairman Powell warned last Wednesday and why the Fed will keep rates higher longer than the market appreciates. The bulls scoffed at the idea the first time around. However, they were surprised by this persistent inflation once again on Friday.

Powell then made it clear the following Tuesday 2/7 at the Economic Forum that these jobs reports led him to believe that they might need to push rates higher...or hold them down. longer to bring inflation back to the 2% target.

This extended warmongering is a big STRIKE 1 against the bulls.

.. Strike 2 launched this Tuesday (2/14). I am referring to the higher than expected Consumer Price Index (CPI) report at +6.4% vs. 6.2% expected. We are obviously far from the Fed's 2% target.

What's even worse is that month-over-month inflation was +0.5%, or 6% annualized... Unfortunately, that count is way too high month-over-month high confirms the Fed's view that the long-term battle against inflation is far from the top.

The immediate reaction to this news was that stocks fell almost 1% at the start of Tuesday's session. Yet surprisingly, the bulls fought back again to almost break even.

These bulls keep seeing positive things that I'm not...maybe they're smoking things that I'm not too."

All of the above set the stage for Thursday's 2/16 Producer Price Index (PPI) report. Indeed, this turned out to be strike 3 for the bulls as it was way too hot, which led to an immediate sell off on Thursday and Friday.

Let me explain why this is so bearish.

The recent bullish rally was based on the idea that inflation was falling faster than expected. This means the Fed was likely to end rate hikes sooner than expected, increasing the chances of a soft landing that would usher in the next bull market.

These 3 recent events are a serious attack on this dovish notion. With inflation still so high, this means the Fed will most likely keep its promise to raise rates to 5% or more...and keep those restrictive policies in place until the end of the year.

When you appreciate the weakness in the economy right now, coupled with more than 10 more months of hawkish policies, plus another 6-12 months of lagged economic effects on this hawkish regime, that's a growing recipe the chances of a recession forming.

Recession = falling corporate profits = falling stock prices

All of the above has made me raise my recession and bear market expectations to around 70-75% (from 65% previously). The main thing holding me back from a higher probability is that Jobs remain incredibly resilient.