The stock market sell-off could get uglier



  • The S&P 500, Nasdaq 100 and Dow suffered heavy losses over the week after the Federal Reserve endorsed a hawkish monetary tightening path
  • Recession fears, coupled with rising interest rates, will continue to reduce risk appetite, preventing equities from making a meaningful comeback.
  • Any attempt to rally can bet to encounter strong selling interest in the short term

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The fundamentals of trend trading

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US stocks had a choppy week amid soaring US Treasury yields after the Federal Reserve made the third consecutive hike of 75 basis points and signaled a steeper path for interest rate hikes over the forecast horizon at its September FOMC meeting. Against this backdrop, the S&P 500 and Nasdaq 100 suffered heavy losses but narrowly avoided retesting their worst levels of 2022. The Dow, however, was not so lucky and made a new low on Friday morning, briefly entering bearish territory.

The widespread narrative is that the Fed’s aggressive normalization cycle, coupled with its promise to maintain a restrictive stance for an extended period, will trigger a painful hard landing, a scenario that could seriously damage the outlook for corporate profits.

While the US economy is holding up better than expected, the the market is looking to the future, implying that tomorrow’s events are more important than today’s developments. Another key point to keep in mind is that economic resilience, reflected in the strength of the labor market, only means that policy makers will have to slam on the breaks even louder cause the kind of demand destruction needed to bring inflation down to the 2.0% target.


S&P 500 chart prepared using TradingView

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There is another overhang for stocks: monetary policy acts with a long and variable lag. This principle suggests that the actions of the Fed over the past seven months have not yet fully materialized in the real economy. As the tightening of financial conditions seeps more broadly into the system, its negative effects should become more visible.

Justified or not, investors seem to be preparing for a Armageddon somehow by continuing to de-risk their portfolios, possibly ahead of significant earnings downgrades as the next reporting period approaches. The bearish sentiment will not fade anytime soon; in fact, the mood could deteriorate before improving in the near term, exacerbated by the negative seasonal factors that tend to plague equities in late September and October.

What does this all mean for the S&P 500, Nasdaq 100 and Dow Jones Industrial Average? From a fundamental perspective, the path of least resistance appears to be lower for these indices, especially with nominal and real yields hitting multi-year highs, clearly obliterating the “TINA” argument for stocks that have benefited. to stocks during the record period. low interest rates. While brief bear market rallies cannot be ruled out, a a sustainable recovery seems difficultwith traders and speculators likely tempted to tone down any rally attempts for now.

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—Written by Diego Colman, Market Strategist for DailyFX

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