Worsening earnings outlook not factored in

Dow Jones Industrial Average has been rallying in Jan 2023. From Fig. 1 above, it is above the MA200 and looks bullish. But it is still rejected at Downtrend line 2. Is it going to break out of the resistance?

Analysts are expecting a recession later this year. Inflation appeared to have peaked in Jul 2022 with the CPI peaking at 9.1%. Inflation have risen at a slower rate and was 6.5% in Dec. They expect the Fed to stop hiking rates as soon as 1Q2023 with last one being 25 basis points in Mar. Then the Fed is expected to pause and cut rates in the second half.

Big tech has been laying off tens of thousands of jobs. The earnings outlook is expected to weaken in the next 6 months. The markets now have only factored in about 7% drop in corporate EPS. In a typical recession, corporate EPS drops about 20%. So markets are likely to have further room to fall.

With China's reopening from Covid-19 lockdowns, its economy will grow at a faster rate with increased demand for almost all types of commodities. Commodities will be bullish in 2023:

This will result in higher inflation but the U.S. and EU may benefit somewhat from the reopening and experience shallower recessions. So the Fed can be more agressive to tame high inflation. The markets may rise, but may be brought back to earth at the FOMC meetings. Where Powell is expected to reiterate that "rates are expected to stay higher for longer". Analysts have chosen to ignore this.

Inflation is growing at a slower rate, but it's still much higher than the Fed's target of 2%.

The Fed is expected to hike rates to combat high inflation even at the expense of causing a recession. If the Fed listens to analysts and repeats the mistake of the 1970s by cutting rates or reducing hikes too early without taming high inflation, then DJII may go nowhere like the chart in Fig. 2.

Hence, I think the Fed will hike rates higher and longer than expected and the markets will resume the down trends.