July was a very positive month for the markets, meaningfully reversing the trend we saw in the first half of the year.  The primary causal factors seemed to be:

1.  A 75bps rate increase from the Fed that was accompanied by what many perceived as a dovish pivot in tone.  
2. Corporate earnings that were not as bad as feared.  
3. A consensus belief that inflation is past the peak on a rate-of-change basis.  

In our June letter, we started by noting the market doesn’t go up or down in a straight line.  We also said that Bear market rallies can be equally as vicious as the downward moves.  We went on to note three of the most likely shapes of the market for the back half of the year: 

1. The market having a vicious snapback rally and then resuming its trend downward. 
2. The market chopping sideways for a while before continuing to trend down. 
3. The bottom being in for this bear market and a resumption of the bull trend.  

So far, path (B) has been taken off the table, leaving us with paths (A) and (C) still in play.  Our Macro model is starting to show a progressively increasing likelihood that Option C could come to pass.  From a macro forces perspective, this has been one of the most uncertain times we’ve seen in recent memory.  

Let’s look at the reasons to consider that the bottom could be in (Path C): 

1. The aggressiveness of the rally in July suggested that there was both a lot of short-covering and that a meaningful amount of cash was on the sideline. If there’s more shorting to cover and more cash on the sidelines, then we should rally meaningfully further. 
2. The Fed does seem to want to do an about-face, even if that’s not the right thing to do for inflation. 
3. An easing of the tensions in the Ukraine could meaningfully bring Oil (and thereby the inflation basket) down. 

The reasons to consider that we have another leg down to come (Path A): 

1. Companies across the size spectrum have begun layoffs and slowed hiring, creating what could be a self-fulfilling economic prophecy.
2. Wage inflation is likely to be stickier than any of the baseline commodities or physical goods that are key inputs.  
3. Geopolitics could ratchet up and get worse, such as Russia holding out natural gas from Europe and plunging Europe into a deep recession that will have spillover effects. 

If the uncertainty that we currently feel manifests in the markets in the near-term, we may end up having to choose between our market bottom call of SPX 3250 and our EOY target of SPX 4450.  While we (really) don’t want to make that call right now, we believe that having a hypothesis is important, even if uncomfortable.  So, if pressed, we’d choose the downside target over the EOY target.  Our primary reasoning comes down to how few times the Fed has actually historically engineered a soft landing in the past.  And despite market pundits increasingly calling for the bottom being in, we have a hard time understanding just how inflation comes in check without a substantial amount of demand destruction.  

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