In another week of whip stock trading, many investors are wondering how far markets will fall.
Investors have often blamed the Federal Reserve for market falls. It turns out that the Fed has often been involved in market reversals as well. Since 1950, the S&P 500 has sold off at least 15% on 17 occasions, according to a study by Vickie Chang, a global markets strategist at Goldman Sachs Group Inc. On 11 of those 17 occasions, the stock market managed to bottom out around the time the Fed began easing monetary policy again.
Getting to this point can be painful. The S&P 500 is down 23% in 2022, marking its worst start to a year since 1932. The index slipped 5.8% last week, the biggest drop since the pandemic-related sell-off in March 2020.
And the Fed has only just begun. After approving its largest interest rate hike since 1994 on Wednesday, the central bank signaled that it intends to raise interest rates several more times this year in a bid to curb inflation.
The tightening of monetary policy, combined with inflation at a four-decade high, has many investors concerned that the economy could be in a downturn. Retail sales, consumer sentiment, housing construction and factory activity data have all weakened significantly over the past few weeks. And although corporate earnings are strong now, analysts expect them to come under pressure in the second half of the year. According to FactSet, a total of 417 S&P 500 companies included inflation in their first-quarter earnings calls, with the highest number dating back to 2010.
Over the coming week, investors will analyze data including existing home sales, consumer sentiment and new home sales to assess the direction of the economy. US markets are closed on Monday for June 16th.
“I don’t think the market’s decline will continue at this rate, but the idea that we’re nearing bottom is really hard to imagine,” said David Donabedian, chief investment officer of CIBC Private Wealth USA.
Mr Donabedian said he discouraged clients from trying to “buy the dip” or buy shares at a discount on the expectation that the market will soon reverse. Even after a harsh sell-off, shares still don’t look cheap, he said. And earnings forecasts are still overly optimistic about the future, he added.
The S&P 500 is trading at 15.4 times forward 12-month earnings, just a hair below its 15-year moving average of 15.7, according to FactSet. According to FactSet, analysts currently expect the S&P 500 companies to report double-digit percentage earnings growth in the third and fourth quarters.
Other investors say they fear the possibility that the Fed may have to act even more aggressively if policymakers are surprised by another higher-than-expected inflation rate. The University of Michigan consumer survey, released earlier this month, showed that households expect inflation to come in at 3.3% five years from now, up from 3% in May. That was the first increase since January. Separately, the Labor Department’s consumer price index rose 8.6% in May from a year earlier, the fastest rise since 1981.
“Our feeling is that the Fed might if the next inflation number is very high again [raise rates] even more so,” said Charles-Henry Monchau, Syz Bank’s chief investment officer, in emailed comments. That could put further pressure on risky assets like stocks, he added.
As the Fed began raising rates again this year, it was hoping for a soft landing, a scenario in which it slows the economy enough to curb inflation but not enough to trigger a recession .
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In recent weeks, many investors and analysts have become increasingly pessimistic that the Fed can pull this off. The data have already shown signs of a slowdown in economic activity. As rate hikes continue to raise the cost of borrowing for consumers and businesses, it’s hard to see how the Fed can avoid a downturn, many analysts say.
The Fed’s moves “increase the risk of a recession starting this year or early next year and frankly increase the risk that they can’t hike rates for that long,” David Kelly, chief global strategist at JP Morgan Asset Management, said on a conference call with reporters Wednesday.
“I wouldn’t be surprised if we had a meeting within a year where the Fed was considering a rate cut,” he added.
Not surprisingly, stocks typically don’t do well during recessions. According to Deutsche Bank research, the S&P 500 has fallen a median of 24% during recessions since 1946.
“If we don’t get a recession, we’re approaching extreme territory,” Deutsche Bank strategist Jim Reid wrote in a note.
The silver lining for investors is that when the Fed begins to move toward monetary easing, markets have historically responded positively and quickly — particularly when the root cause of its decline, according to Goldman Sachs analysis related to central bank policy.
No one is sure when exactly the Fed will kick in and how much more pressure the economy could get in the meantime.
“I expect the summer to be very choppy,” said Nancy Tengler, chief investment officer at Laffer Tengler Investments.
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