Welcome to my latest video presentation for Mind Over Markets. The article below is a condensed transcript; the video contains several charts and additional details.

The combination of recession fears, rising interest rates, and corporate earnings deceleration has sent stocks tumbling. So much for a Santa Claus rally. The main culprit for stealing the Christmas hopes of investors? The surprisingly “Grinchian” comments of Federal Reserve Chair Jerome Powell.

Equity markets fell for the second consecutive week, as Wall Street sentiment turned lower in the wake of the Federal Reserve Open Market Committee meeting December 13-14. The hike in interest rates of 0.50% was expected, but Powell’s stern remarks at the post-meeting press conference spooked investors.

Powell said: “We continue to anticipate that ongoing increases will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time. In addition, we are continuing the process of significantly reducing the size of our balance sheet. Restoring price stability will likely require maintaining a restrictive policy stance for some time.”

We’re seeing that the bear market still has bite. Also undermining stocks is the latest retail sales report. Excluding autos, retail sales in the U.S. shrank by 0.2% month-over-month in November 2022, the worst decline since December last year and defying market forecasts of a 0.2% gain.

This unexpectedly weak retail sales report showed that the Fed’s tightening is starting to negatively affect consumer behavior and the economy, further stoking recession fears.

To make up for lost time and get ahead of the curve on inflation, the Fed has initiated this year its steepest tightening in four decades. You’d have to go back to the infamous Paul Volker era of the late 1970s and early 1980s for a series of rate hikes that are more dramatic than what we’ve seen in 2022.

But it’s not just the Fed. Central banks around the world are grappling with global inflation, aggressively hiking rates in their respective countries. Global tightening is likely to continue through the first quarter of 2023.

Add China’s COVID woes to the mix, and investors are worrying about a recession with global reach. Last week was tough on U.S. and international stocks.

Bearish sentiment is emerging, despite better-than-expected consumer price index (CPI) inflation data for November, which showed that inflation is cooling down.

CPI inflation data for November came in below expectations, with headline inflation of 7.1% year-over-year compared to expectations of 7.3%. Core inflation came in at 6.0%, also below forecasts for 6.1% and lower than last month’s 6.3%.

The Fed’s “dot plot,” released last week, also surprised the markets. An estimate of where interest rates are headed, the dot plot indicated a peak federal funds rate of 5.1% in 2023. This rate was slightly above the market consensus of 4.8% to 5.0% heading into the Dec. 13-14 FOMC meeting.

Fed Chair Powell emphasized that while recent inflation reports have been encouraging, inflation remains elevated and well above the Fed’s 2.0% target. Powell went out of his way to say that it was too soon to discuss rate cuts.

Powell’s overall message? Curb your enthusiasm. The inflation battle still has a long way to go, even if it means causing economic pain.

Here’s the good news: Once we’ve reached the peak in the fed funds rate, historically the next 12 months are positive for both the equity and bond markets.

WATCH THIS VIDEO: Economic Crosscurrents, Explained

The first few months of 2023 are likely to be soft for the economy, corporate earnings, and stocks. That said, we still might dodge a recession, especially in the context of robust jobs growth.

The back half of 2023 still holds enormous promise. What’s more, considering the declines we’ve already endured this year, we’re unlikely to see a new, dramatic downward leg in the stock market next year. As inflation continues to abate, central banks will have less justification for hawkishness.

In terms of portfolio allocations, value and defensive plays should dominate your stock sleeve. But as 2023 gets underway, market leadership is likely to transition to cyclical sectors that dominate during a recovery. Growth-oriented sectors are poised to come back into style.

The week ahead…

The economic calendar leading into the Christmas weekend is a busy one:

NAHB home builder’s index (Monday); building permits and housing starts (Tuesday); consumer confidence index and existing home sales (Wednesday); initial jobless claims and index of leading economic indicators (Thursday); the personal consumption expenditures price (PCE) index, disposable income, consumer spending, durable orders, consumer sentiment and inflation expectations, and new home sales (Friday).

The best way to describe stock market performance this year is: stink, stank, stunk. But the table is set for a better new year.

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John Persinos is the editorial director of Investing Daily.

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