The 'problematic' stock rally will fade as the Fed wrangles sticky inflation and recession hits in the 2nd half of the year, Credit Suisse strategist says

• The rally in stocks that's kicked off 2023 is "problematic," according to Credit Suisse strategist Patrick Palfrey.
• Palfrey warned that gains will be fleeting as the Fed continues to battle sticky inflation.

The ongoing stock rally is "problematic," and the market will falter in the second half of the year as the Federal continues to wrangle sticky inflation and a recession hits the economy, according to Credit Suisse strategist Patrick Palfrey.

In an interview with CNBC on Wednesday, Palfrey warned that S&P 500's strong start to the year was unlikely to last, as gains in recent weeks have largely been led by the biggest losers of 2022. That's a sign speculation is leading the market – and the rally will falter as investors wake up to the longer-term economic headwinds.

"The health of the rally is really led by speculative assets. I think longer-term, it's more problematic for this to continue," he warned, pointing to inflation, which remains well above the Fed's 2% target. Though prices cooled to 6.5% in December, inflation is likely to remain sticky in the second half of the year, Palfrey said. While goods prices are falling, services prices are still high, a consequence of a a tight labor market.

Stubborn inflation will push the Fed to "reengage" with its tightening policy in the second-half of the year, and that spells trouble for stocks. The Fed hiked interest rates 425-basis-points in 2022 to lower prices, a move that wiped away 20% from the S&P 500 and marked the index's worst performance since 2008.

As the Fed hikes rates and struggles to rein in inflation in the last half of the year, a recession could hit the economy, causing a sell-off in the market, Palfrey warned. He predicted the S&P 500 to clock in at 4050, by year-end, slightly lower than current levels.

"Recessionary risks haven't really been taken off the table. I think those are going to be a headwind for the market as we start to approach the latter half of the year," Palfrey warned.

Wall Street strategists have also warned of a recession that could ravage stocks, with Bank of America, Citigroup, and JPMorgan foreseeing at least a mild downturn this year, with Bank of America predicting a 24% decline in the S&P 500 in early 2023. Other commentators have warned of a steeper drop, with legendary investor Jeremy Grantham predicting a huge 50% stock market crash.