Will the Federal Reserve Kill the Stock Market Rebound?


A summer rebound is raising hopes that the bear market in U.S. equities has bottomed out, but a meeting of Federal Reserve policymakers this week could test the nerves of potential buyers.

“I expect we will continue to see market volatility until investors see more compelling evidence that this period of Fed hawkishness is behind us, and I don’t expect that. let that be the message” when central bankers wrap up a two-day meeting on July 27, Lauren Goodwin, economist and portfolio strategist at New York Life Investments, said in a phone interview.

Disappointing results from the Snap Inc. SNAP social media platform,
pared a weekly rise in stocks on Friday, but benchmarks still posted healthy gains. The S&P 500 SPX,
rose 2.6% last week to end near 3,962 after crossing the 4,000 threshold early Friday for the first time since June 9. The Dow Jones Industrial Average DJIA,
recorded a weekly gain of 2%, while the Nasdaq Composite COMP,
advanced by 3.3%.

This week’s rebound lifted indices from 2022 lows after the S&P 500 fell to 3,666.67 on June 16.

See: Has the bottom of the stock market been reached? What the pros are saying after the S&P 500 tests 4,000

The rebound was fueled in part by momentum that saw investors treat bad news on the economic front as good news for equities, James Reilly, an economist at Capital Economics, said in a Friday note.

That may sound odd, but it likely reflects, in part, investors’ view that weaker economic data will cause the Fed to raise interest rates less than previously thought, Reilly wrote. There’s evidence of that in market expectations for rate hikes, which have been scaled back recently (see chart below), a development that has supported equity valuations, he said.

Capital saving

The market expects the Fed to raise interest rates by 75 basis points on Wednesday, matching the increase seen in June, which was the largest since 2002.

Lily: The Fed could get lucky or things could go wrong. A guide to where the economy could go from here

Meanwhile, the past week has provided ample evidence of a slowdown in economic activity.

The U.S. Services Purchasing Managers Index fell to a 26-month low of 47 in July, from 51.6 the previous month, based on a ‘flash’ survey by S&P Global Market Intelligence . A reading below 50 signals a contraction in activity.

On Thursday, weekly jobless claims hit their highest level since November but remained historic low, the Philadelphia Fed’s manufacturing index unexpectedly fell deeper into negative territory, and the Conference Board said its main economic index shows that a US recession towards the end of the year and the beginning of the next is now likely.

US economic data due next week includes an early estimate of second-quarter gross domestic product, which is expected to show a second straight contraction. Although such an outcome is often described as a technical recession, a still strong labor market and other factors make it unlikely that the National Bureau of Economic Research, the official arbiter of the business cycle, will declare it. a.

Related: A “false” recession? US economy doing well for now despite weak GDP

Reilly said he doubts the slowdown in activity will slow the Fed’s turnover.

“Our central forecast is that U.S. economic growth will remain weak, but not so weak as to deter the Fed from aggressive hikes for the rest of this year. Such an outcome would likely mean higher discount rates and disappointing growth. corporate earnings, which would be a pretty toxic combination for stock prices,” he wrote.

Many Fed watchers, including some ex-policymakers, see a Fed determined to convince market participants of its desire to stifle inflation.

Former Richmond Fed Chairman Jeffrey Lacker said Friday that policymakers should continue to raise interest rates even in a recession. “Letting go of the brake before inflation subsides” is just a “recipe for another recession to come,” Lacker said, in an interview with Bloomberg Television.

Even if the economy slowed fast enough to set Fed policymakers backing down, it probably wouldn’t be good news for stocks, Reilly argued. That’s because corporate earnings would weaken more than the company already expects, he said. It’s also unlikely support stocks saw as expectations for the fed funds rate moderated would continue in a severe downturn, with history showing that valuations have tended to fall during periods when appetite for risk has deteriorated.

Goodwin, however, said recent stock market resilience was more important.

“The market, on average, was anticipating a tougher earnings season than what we’ve seen so far,” while forecasts were also more bullish, she said, acknowledging it was still too much. early.

As of Friday morning, 75.5% of S&P 500 companies that said they beat analysts’ consensus forecasts for earnings per share. The average was around 4.7%, according to I/B/E/S data provided by Refinitiv. That compares with 66% of companies beating EPS estimates in a typical quarter since 1994, and an average beat margin of 9.5% for the previous four quarters.

In terms of revenue, 68.9% of companies beat forecasts by about 1.3% on average, compared to 62% of companies beating in a typical quarter since 2002 and an average beat rate of 3 .4% for the previous four quarters.

Revenue monitoring: Here are 5 things we’ve learned so far from earnings season

Markets were dominated by concerns over runaway inflation and the threat of recession, so a “slightly more bullish” reading of companies so far was a dose of good news, Goodwin said.

Indeed, investors appeared to swing between fears about inflation and recession, market watchers said. Searing inflation was the main concern as stocks fell and Treasury yields soared in the first half of 2022. More recently, market action indicates investors have become more focused on the prospect of a recession as the Fed aggressively tightens policy.

So what should investors do as the focus shifts from inflation to recession?

Goodwin said inflation will remain a primary consideration when it comes to portfolio positioning, as recession-proof assets such as cash, Treasuries and high-quality corporate bonds that have performed over the past of the last cycle, can considerably slow down the creation of wealth.

To deal with expected volatility, New York Life is improving quality within asset classes. For example, she is heavily overweight high-yield debt in her portfolios on expectations that the business environment will remain fairly robust, she said, but its quality is rising within high yield.

With rising consumer prices in mind, that also means looking at stocks and fixed-income securities whose cash flows are linked to inflation, she said.


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