The stock market is tumbling because investors fear recession more than inflation

A stock-market paradox, in which bad news about the economy is seen as good news for equities, may have run its course. If so, investors should expect bad news to be bad news for stocks heading into the new year — and there may be plenty of it.

But first, why would good news be bad news? Investors have spent 2022 largely focused on the Federal Reserve and its rapid series of large rate hikes aimed at bringing inflation to heel. Economic news pointing to slower growth and less fuel for inflation could serve to lift stocks on the idea that the Fed could begin to slow the pace or even begin entertaining future rate cuts.

Conversely, good news on the economy could be bad news for stocks.

So what’s changed? The past week saw a softer-than-expected November consumer-price index reading. While still running mighty hot, with prices rising more than 7% year over year, investors are increasingly confident that inflation likely peaked at a roughly four-decade high above 9% in June.

See: Why November’s CPI data are seen as a ‘game-changer’ for financial markets

But the Federal Reserve and other major central banks indicated they intend to keep lifting rates, albeit at a slower pace, into 2023 and likely keep them elevated longer than investors had anticipated. That’s stoking fears that a recession is becoming more likely.

Meanwhile, markets are behaving as if the worst of the inflation scare is in the rearview mirror, with recession fears now looming on the horizon, said Jim Baird, chief investment officer of Plante Moran Financial Advisors.

That sentiment was reinforced by manufacturing data Wednesday and a weaker-than-expected retail sales reading on Thursday, Baird said, in a phone interview.

Markets are “probably headed back to a period where bad news is bad news not because rates will be driving concerns for investors, but because earnings growth will falter,” Baird said.

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