The market continues to act as if investors entered 2023 light on risk and ill-positioned for positive economic outcomes. The S & P 500’s traction right around the “down-20%-from-the-peak” level near 3800 has given way to a break higher on a mix of value-stock leadership, China-reopening dynamics, reflex bounces in bombed-out mega-cap tech and a refusal of the macro data to rule out a softer economic landing just yet. The result is still for now a rally within a broader downtrend but the pattern coming off the latest “lower high” is so far different from the steep slides coming off the spring and summer 2022 highs that resulted in “lower lows” within two months. Caution entering 2023 has surely been understandable. Several leading indicators of recession have been flaring for months, the Fed has pushed back on market efforts to anticipate a dovish policy turn and equities are not – from a top-down view – particularly cheap. Yet the oddities of this cycle (the extreme high levels of spending and profitability, the unusually cushioned consumer and corporate balance sheets, structural labor-market tightness, pent-up demand for capital investment) make it a noisy backdrop in which to discern the proper signals . I continue to point out that while the S & P 500 trades at nearly 17-times forward earnings forecasts, around the 20-year average and merely around “fair” rather than “cheap,” the top-heaviness of the index valuation means the equal-weight S & P closer to 14x and the S & P Mid Cap 400 around 13-times. Yes, there could well be downside risk to earnings… Morgan Stanley says some 10-15% risk to current 2023 estimates. Can’t rule out a profit shock from margin erosion and perhaps softer employment trends to come. But the present 4% year-ahead consensus profit-growth estimate is the lowest in at least 35 years, says Deutsche Bank – including several years when outright earnings declines occurred. In other words, numbers might still have to come down, but they’d likely be falling out a first-floor window, the process has been underway for months and the market isn’t wholly unaware of this. Big question remains whether a bear market can stop in the vicinity of “fair” value where the forward equity returns look to be roughly in line with the long-term average (say 7%-ish annualized), or whether the typical work of a bear market to overshoot to the downside and set up a better forward-return path is still to come. Credit markets are sturdy, benefiting from demand for reliable yield for a level of income unavailable in a dozen years and as a buffer against equity risk. Investment-grade credit spreads vs. Treasuries shown here look a bit like the path taken in the recession-anticipation/Fed-overtightening scare of late-2018, which gave way to another year or so of stable and upward-trending markets. This all also represents a loosening of financial conditions that the Fed seems not happy to see, though not to the level of last August. But financial conditions are the tool, not the job itself, and the market realizes that if inflation shows downside momentum the Fed will not get incrementally tighter. Who knows if “higher for longer” rates are fully priced into markets, but an equilibrium might not be far off. If CPI data Thursday contradicts the market’s sense that inflation is in a fairly rapid retreat this rally would probably find its next gut check somewhat short of the level where it would have reached escape velocity. Market breadth is strong for a second straight day, helping the supply/demand tally though there has not been the kind of decisive burst of upside volume and “get me in right now” action that should mark the transition to a durable uptrend. VIX is steady near 21, somewhat under-reacting to market swings lately, perhaps as short-term options become more a vehicle of choice for hedgers/index speculators.