Stocks historically do not fall until the Fed relaxes

Another week of whipsaw stock trading has left many investors wondering how far the markets will fall.

Investors have often blamed the US Federal Reserve for the market disasters. It turns out that the Fed has often played a role in market upheavals. Going back to 1950, the S&P 500 has sold at least 15% in 17 cases, according to research by Vickie Chang, strategic global market analyst at Goldman Sachs Group Inc. In 11 of these 17 cases, the stock market managed to reach the bottom only when the Fed turned to easing monetary policy again.

Getting to this point can be painful. The S&P 500 has fallen 23% in 2022, marking its worst one-year start since 1932. The index fell 5.8% last week, its biggest drop since the March 2020 pandemic sell-off.

And the Fed has just started. After approving the biggest rate hike since 1994 on Wednesday, the central bank indicated it intends to raise interest rates several times this year in order to reduce inflation.

The tightening of monetary policy, combined with inflation at a four-decade high, has left many investors fearing that the economy could go into recession. Data on retail sales, consumer sentiment, housing construction and factory activity have shown a significant decline in recent weeks. And while corporate profits are strong now, analysts expect them to come under pressure in the second half of the year. A total of 417 S&P 500 companies reported inflation in their first-quarter earnings calls, the highest number since 2010, according to FactSet.

Next week, investors will analyze data, including existing home sales, consumer sentiment and new home sales, to gauge the course of the economy. US markets are closed on Monday for the fourth of June.

“I do not think the market is going to continue at this rate, but the idea that we are coming down – it’s really hard to come up with,” said David Donabedian, CIBC Private’s chief investment officer. Wealth USA.

Fed Chairman Jerome Powell on the NYSE screen on Wednesday, when the central bank signaled that it intends to raise interest rates several times this year.


Photo:

BRENDAN MCDERMID / REUTERS

Mr Donabedian said he had discouraged customers from trying to “buy the dive” or buy discounted shares in the hope that the market would change soon. Even after a punitive sale, the shares still do not look cheap, he said. And earnings forecasts still look very optimistic for the future, he added.

The S&P 500 is trading 15.4 times higher than expected gains over the next 12 months, according to FactSet, just one hair below its 15-year average of 15.7. Analysts still expect the S&P 500 companies to report double-digit profit growth in the third and fourth quarters, according to FactSet.

Other investors say they remain skeptical about the possibility that the Fed will need to act even more aggressively if policymakers are surprised by another unexpectedly high inflation. The University of Michigan Consumer Survey, released earlier this month, found that households expect inflation to fluctuate by 3.3% in five years from now, from 3% in May. This was the first increase since January. Separately, the Ministry of Labor’s consumer price index rose 8.6% in May from the same month a year ago, the fastest rise since 1981.

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“Our sense is that if the next inflation rate is still very high, the Fed could [raise rates] “Even more so,” said Charles-Henry Monchau, chief investment officer at Syz Bank. This could put further pressure on risky assets such as stocks, he added.

When the Fed started raising interest rates again this year, it said it hoped to achieve a mild landing, a scenario in which it was slowing the economy long enough to curb inflation, but not so much as to trigger a recession.

In recent weeks, many investors and analysts have become increasingly pessimistic that the Fed will be able to do this. The data have already shown signs of cooling of economic activity. As interest rate hikes further increase borrowing costs for consumers and businesses, it is difficult to imagine a way for the Fed to avoid a recession, many analysts say.

The Fed’s moves “increase the risk of a recession starting this year or early next year and increase the risk of honestly not being able to continue raising interest rates that much,” said David Kelly, JP Morgan’s chief global strategic analyst. Asset Management. , he said in a teleconference with journalists on Wednesday.

“I would not be surprised if within a year we have a meeting where the Fed is considering lowering interest rates,” he added.

As expected, stocks usually do not do well during the recession. The S&P 500 has fallen an average of 24% during the recession dating back to 1946, according to a Deutsche Bank survey.

“If we do not have a recession, we are approaching extremes,” wrote Deutsche Bank strategic analyst Jim Reid in a note.

The advantage for investors is that, as the Fed began to focus on easing monetary policy, markets responded historically positively and quickly – especially if the main reason for their slippage was central bank policy, according to its analysis. Goldman Sachs.

What one is not sure about is exactly when the Fed will change speed and how much more pressure the economy may face in the meantime.

“I expect the summer to be very volatile,” said Nancy Tengler, chief investment officer at Laffer Tengler Investments.

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Write to Akane Otani at akane.otani@wsj.com

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