the shortterm direction of stocks seems likely to be determined by the combination of inflation and the number of rate hikes needed to combat it an additional variable is the rising probability of recession if the federal reserve fed is forced to continue to hike aggressively the august reading for consumer inflation cpi is released on tuesday and is expected to show another decline in the yearoveryear reading consensus estimates call for 8 yearoveryear down from 85 last month and the 91 peak in june this decline in the headline rate seems likely based on the almost forty cents per gallon decline in gasoline prices during august in addition the cleveland fed’s cpi inflation forecast has declined to 82 yearoveryear the continued decline in the headline inflation rate is a necessary but not sufficient condition for the fed to deviate from its expected aggressive rate hike path the fed and markets will be looking for some improvement in the stickier elements of inflation like wages and rent given the resilience of the economy and the labor market in the face of rate hikes there is not likely to be much relief on this front the oneyear forward fed funds futures rate is a crucial variable for recession probability and treasury yields expectations for the fed funds rate in one year reached a high reading of 406 in midjune when stocks hit a low and treasury yields made a high recently expectations for the future fed funds rate have been climbing and ended last week at 390 markets are already pricing a 75 basis points 075 rate hike at the september 21 meeting with 50 basis points in november and 25 in december even if the cpi report this week shows improvement investors should expect the 75 basis points hike at the upcoming meeting in any case any movement based on the inflation reading will likely be in future fed meetings there are quite a few yield curves that can be used to weigh future recession probabilities since the focus has been on fed hikes it is worth considering the oneyear forward fed funds futures rate versus the 10year treasury rate this yield curve is currently inverted meaning that the yield on the 10year is below the expected fed funds rate one year in the future the betterknown 10year versus 2year treasury yield curve also remains inverted according to bloomberg the median forecaster has a 50 chance of a recession in the coming 12 months with the consumer being the driver of the us economy the august retail sales report on thursday will be critical while headline retail sales are expected to be unchanged monthovermonth the more important control group which feeds the gdp calculation should rise 05 monthovermonth the robust labor market rising wages and a decline in gasoline prices should allow consumers to boost economic growth while a possible recession should be expected next year this quarter’s data should be firming a bit cyclical stocks which are more economically sensitive have begun to outperform staples confirming the fundamental view of some economic buoyancy it is premature to call it a trend but it is worth continuing to watch one area that seems logical to avoid in this environment is the high expected growth and expensive valuation it is selfevident that this segment of the markets is most susceptible to higher rates and a loss of risk appetite that likely accompanies recession fears as proxied by the ark innovation etf arkk  the high expected growth and expensive valuation segment shows a remarkable negative correlation with yields as evidence of the impact of higher yields the etf was down 62 from its 2022 high at the midjune low arkk is an excellent example because its portfolio has negative estimated earnings in the coming year but is expected to have a superior longterm earnings growth rate the arkk portfolio also has a higher valuation with an estimated forward enterprise valuetoebitda ratio of 42times versus 12times for the sp 500 a relative beneficiary of higher yields has been value stocks the value space continues to look like a good pond to fish in with the relative valuations of value stocks historically very inexpensive relative to growth stocks in addition growthatreasonableprice garp stocks with good balance sheets fit the bill for being mindful of valuation while providing opportunities for longterm earnings growth the path for stocks is likely choppy as the market struggles with the rising odds of an economic downturn caused by the fed’s rate hikes to fight inflation recently the extreme negative investor sentiment and the pricing of significant fed hikes have helped stocks bounce investors should have an asset allocation to ride through any economic turmoil and focus on quality attractivelyvalued companies that can survive the looming recession and thrive after