Last week’s cooler-than-expected CPI reading for October set off an aggressive risk-on-buying euphoria that has many investors thinking the bottom is in. The S&P 500 is now up nearly 15% from the lows seen immediately after September’s strong CPI print as investors feel comfortable with the idea that inflation has peaked.

With Santa Claus’ arrival right around the corner, many are getting a jump start on the strong year-end seasonal strength trade. Should you chase this rally?

In the words of ESPN’s immortal college football commentator Lee Corso, “Not so fast my friends.” I think caution is warranted and I would use this strength to get defensive in anticipation of a very tough equity outlook for 2023.

The Fed Determines Bull or Bear Market

While investors rejoiced the perceived peak in inflation last month, the real questions are how quickly inflation will come down and whether the Federal Reserve can stop its aggressive interest rate hiking cycle. This is important because whether the Fed is adding or subtracting liquidity from markets is the key determinant of whether we are in a bull or bear market.

The market has struggled mightily in 2022 as the Fed has tightened monetary policy, so investors are looking for any signs that 2023 can be better once the Fed starts to loosen again.

While markets last week used the weaker CPI data to immediately begin assuming fewer interest rate hikes were coming along with the potential for interest rate cuts later in 2023, a closer look at the data suggests that we are not out of the woods yet. I think the Fed will continue to tighten monetary conditions from here, and thus, the bear market is not over.

The Fed has a mandate of maximum employment and price stability. Regarding its employment mandate, we continue to observe an economy that is operating with an extremely tight labor market. The number of job openings to job applicants runs above 1.5, which suggests more job openings than workers available, a level that is even tighter than we saw pre-Covid-19. While we have begun to see some white-collar job layoffs across the tech sector, large swathes of the country continue to express concern that they still cannot fill service jobs across many industries.

Fed Chair Jerome Powell has said the labor market remains “extremely tight” and worries that it could lead to a 1970s-style wage/price spiral. The Fed is actively working against this outcome with its interest rate tightening agenda. As long as the labor market remains firm, we will not be seeing any data that suggests that the Fed is ready to adjust its tightening policies quite yet. I don’t really see a rapidly deteriorating labor market in the next few quarters.

Inflation Is Sticky

Shifting to inflation, the Fed is trying to bring the prices in the economy down to the 2% level. While the CPI reading last week did show some heat has come off the inflation boil, core inflation was still up 7.7% from last year, down from 8.2% last month. And when we look under the hood, we can see that inflationary pressures still are broad and vast in the economy.

Various Fed districts provide their own parsing of the data to give some insight on this. We can see from the Atlanta Fed’s Core Sticky CPI measure for October that prices were up 6.5% YOY and 3-month annualized prices were up 7.2%, showing little signs of deterioration quite yet.

The Cleveland Fed also has its own metric known as the 16% trimmed-mean CPI, which is a weighted average of one-month inflation rates of components whose expenditure weights fall below the 92nd percentile and above the 8th percentile of price changes. The benefit of using this metric is that it omits outliers (small and large price changes) to focus on the interior of the distribution of price changes to provide a better signal of the underlying inflation trend than using the CPI alone.

We can see from the 6.95% reading in October that we remain far away from the Fed’s stated goal of 2%. As long as there remains broad-based inflationary pressures in the economy, the Fed will struggle to move off its tightening agenda.

Don’t Fight the Fed

My investment framework focuses on the notion that understanding whether the Fed is adding or subtracting liquidity from the economy is the most important driver of whether we are in a bull or bear market.

With inflation still too high and the labor market remaining very tight, the Fed will not be able to quickly transition back to providing financial accommodation to the economy or markets any time soon. Without this, the economy will struggle to maintain enough growth to provide companies with sufficient momentum to show strong earnings growth in 2023.

And with interest rates continuing to rise and likely to hold at elevated levels, investors will not be able to rely on multiple expansion either to help most stock positions. I say it’s better to use the Santa Claus rally to get your portfolio in a more defensive construct for 2023. While recent trading momentum gives a sense that the worst is behind us and the “FOMO” is real, keeping a high cash pile remains a good idea while we wait for more tangible evidence that the economy has deteriorated enough to show labor market and inflation weakness in such a way that the Fed can provide liquidity again. That will turn this bear market to bull and we will be on our way.

On the date of publication, Craig Shapiro did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.