The S&P 500 lost almost 20% in 2022 — the worst year since 2008 amid multi-decade high inflation, rising interest rates, and fading economic growth.
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However, US markets have bounced back in recent months with the S&P 500 rising 14% since its October 2022 low.​

While it’s been a strong start to the year, economic uncertainty has left many questioning if this is simply a bear market rally with more pain to come.

With the fourth quarter earnings season winding down in the US, it’s apparent that the share market’s recent strength isn’t reflecting company results. Broadly speaking, results have been underwhelming with S&P 500 earnings per share having contracted following weakening profit margins in prior quarters.

On the other hand, while earnings have disappointed, consumer spending and inflation remain higher than expected, raising the prospect of a second year of rate rises from the Federal Reserve.

These figures are strengthening concerns around the US entering a recession. That is, if a recession hasn’t begun already.

You see, while ‘recession’ might seem like a straight forward technical term, the question around whether the US is already in or is facing a recession is widely debated amongst market commentators, economists and politicians.

Most countries define a recession as two consecutive quarters of negative gross domestic product (GDP). Under that definition, the US technically entered into a recession in the mid-2022.

Yet that assessment isn’t so straight forward in the US, where a recession is more generally accepted as a significant decline in economic activity over an extended period of time. It involves negative gross domestic product (GDP), along with rising unemployment levels and declining income, falling retail sales, and contracting manufacturing.

Under that definition, the US has not yet entered a recession in the current cycle. The flexibility of the definition may mean the US escapes a recession entirely.

Regardless, this uncertainty is likely to weigh on share prices, capping any surge higher until markets have a better sense of both the timing and severity of a recession.

​To support the economy during the pandemic, the Federal Reserve and central banks worldwide adopted policies of low interest rates, which fuelled spending and inflation.

Since economies opened back up, these ultra-low interest rates have been part of the centraul causes to rising inflation. In response, the same institutions have scrambled, raising rates at a record pace to try to halt inflation.

After peaking at 9.1% last June, the annual U.S. inflation rate was 6.4% in January 2023. While this was down from 6.5% in December, it was a smaller decline than the 6.2% that the market forecast.

So while it’s a good sign that inflation looks to be breaking, concerns remain that in its efforts to fight inflation the Federal Reserve will overshoot and tighten money and credit to the point that it causes a recession. And that 6.4% January inflation figure, means the Fed still has a long way to go to bring inflation down to its 2% target.

This month the Federal Funds rate, which influences the interest rates banks charge, was raised to a range of 4.5% to 4.75% — the eighth consecutive hike. Markets now expect the Fed Funds rate to reach 5.25% to 5.50% this year.

Halting inflation is high on the agenda, but this must be balanced with the risk of sending the economy into recession. The hope is that the Fed can do just enough to offset inflation, but not so much as to actually see a recession. The fear being that it will overshoot.

Investors may be interested to know that during the early part of a recession, the stock market typically has negative returns due to hits on corporate earnings. However, once bear markets bottom, there’s typically a significant rally where it seems the market has got ahead of itself, then six to nine months later it makes sense. What’s difficult is knowing when it’s the bottom.

Barring a more severe economic downturn, investors may have already endured the worst of a recession-related market selloff during 2022 with expectations already priced in.

If October was in fact the market bottom, it will come as one of the highest valuation troughs ever. The S&P 500 was trading at about 17x earnings at that time — much higher than historical bear market bottom multiples.

No one knows how this will play out. At this stage the market broadly anticipates a US recession this year, with it likely still months before becoming obvious if a downturn is a foregone conclusion or avoidable. In the meantime, the outlook for the stock market will hang in the balance.

Then again, the US may avoid a recession altogether if the economy strengthens, inflation falls and the Federal Reserve pauses interest rate hikes. With low expectations largely priced in already, this scenario could spur a market rally.