The case for a bear market target of around 2500 on the S&P is a good one. Reading the following comments from a ZH article about Zoltan Pozsar’s thoughts on the matter, reinforced some of my own. If you look at the chart below, you will notice that a target around 2500 would represent a drop from the high of a little bit less than 50% while technically finding support in the general area of the late 2018 low and above the 2020 low. I doubt the FED will get exactly what it wants but that level should help cool off inflation since it would be in conjunction with a likely recession.                         

“Here are Pozsar’s key points.

Forget The Fed’s Official Dual Mandate

The Fed’s dual mandate, of course, is to control inflation and maximize employment. In addition, as Poszar notes, it’s tasked with insuring financial stability (as during 2008). Poszar says that inflation is so bad now, and the Fed is so far behind the curve, that only fighting inflation matters to it now. Poszar quotes a recent statement by President Biden saying fighting inflation is his top economic priority and expressing support for the Federal Reserve to point out that the Fed has the political license to do whatever it takes to rein in inflation.

Poszar doesn’t mention it, but the outcome of November’s midterm elections being considered largely a fait accompli also would seem to give the Fed license: if the incumbent party is already predicting doom, the Fed can’t be blamed for it.

The Fed Needs Stocks to Fall

This is what they actually mean when they talk about the need to “tighten financial conditions”. In support of this claim, Poszar cites a Bloomberg column by his former boss, former NY Fed President Bill Dudley, ominously titled, “If Stocks Don’t Fall, The Fed Needs To Force Them”. The Fed also needs real estate to fall and (more controversially), unemployment to rise, per Poszar.

This all makes sense intuitively, if you think about it. You just need to invert the status quo since the Fed last conquered inflation in the early ’80s under Paul Volker. After that, and up until the COVID lockdowns, the Fed’s primary concern was deflation, rather than inflation. In a deflationary environment, consumers are hesitant to spend, because they’re waiting for prices to drop further. That, in turn, can fuel more deflation. One way to encourage consumers to spend is though the wealth effect. If they see their IRAs and 401(k)s balances rise, they feel richer, and are more inclined to spend money.

If rising stocks make consumers want to spend more, heating up inflation with their demand, what would make them want to spend less, cooling inflation down? Correctamundo, readers: falling stocks is the answer. How much will they need to fall? After saying he won’t offer a precise target, Poszar offers this guidance:

At 4,000, the Fed does not seem content, and in the grand scheme of things, this is where the Fed would change its tune if it would still be writing a put. At 3,500, we would have lost all of the post -pandemic gain s in market wealth, but that level for stocks still feels like a put option, just with a lower strike price. At 2,500, we would lose not only all of the post -pandemic gain s, but would eat into some of the pre -pandemic gains too. And if something indeed happened to the supply of labor post -pandemic (and some of that is wealth related), then to cool price pressures, maybe a pre -pandemic wealth level is appropriate indeed.”