Stocks Historically Don’t Bottom Out Until the Fed Eases

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Investors Ask How Long The Selling Will Last After S&P 500’s Worst Week Since March 2020

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Investors have often blamed the Federal Reserve for the market’s downfall. It turns out that the Fed often has a hand in market changes as well. Going back in 1950, the S&P 500 sold at least 15% on 17 occasions, according to research by Vicki Chang, a global market strategist at Goldman Sachs Group Inc. Only around that time did the Fed again shift toward loosening monetary policy.

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Getting to that point can be painful. The S&P 500 has fallen 23% in 2022, its worst start to a year since 1932. The index has lost 5.8% last week, its biggest drop since the pandemic-fueled selloff of March 2020.

And the Fed has just started. On Wednesday, after approving its biggest interest rate hike since 1994, the central bank indicated that it intends to raise rates several times this year to try to moderate inflation.

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Tight monetary policy, with inflation running at a four-decade high, has many investors fearing that the economy could go into recession. Data on retail sales, consumer sentiment, home construction and factory activity have seen significant declines in recent weeks. While corporate earnings remain strong, 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 mentioned inflation on their earnings calls for the first quarter, the highest number in 2010.

Over the coming week, investors will analyze data including existing-home sales, consumer sentiment and new-home sales to gauge the trajectory of the economy. US markets are closed on Monday for Juneteenth.

“I don’t think the market will continue to decline at this pace, but the idea that we’re on the downside – it’s really tough,” said David Donabedian, chief investment officer at CIBC Pvt. money usa

Mr Donabedian said he discouraged customers from trying to “buy the dip” or buy shares at a discount, with the expectation that the market would soon turn. He added that even after a punitive sell-off, the stocks still don’t look cheap. And earnings forecasts still look very optimistic about the future, he said.

According to FactSet, the S&P 500 is trading at 15.4 times expected earnings for the next 12 months, just below its 15-year average of 15.7. According to FactSet, analysts still expect S&P 500 companies to post double-digit percentage earnings growth in the third and fourth quarters.

Other investors say they are wary of the possibility that the Fed may have to act even more aggressively, should policymakers be surprised by another unexpectedly high inflation reading. The University of Michigan consumer-sentiment survey, released earlier in the month, showed households expect inflation to accelerate from 3% in May to 3.3% five years from now. This is the first increase since January. Separately, the Labor Department’s consumer-price index rose 8.6% in May from the same month a year earlier, the fastest increase since 1981.

“Our sentiment is that if the next inflation figure is too high again, the Fed may.” [raise rates] And even faster,” said Charles-Henri Monchau, chief investment officer at Sage Bank, in emailed comments. This could put further pressure on riskier assets like stocks, he added.

When the Fed began raising interest rates again this year, it said it expected to pull off a soft landing, a scenario in which it slows the economy to rein in inflation but not so much. This triggers a recession.

Within recent weeks, many investors and analysts have become increasingly pessimistic that the Fed will be able to pull this off. The data has already indicated a cooling off of economic activity. Many analysts say that as the rate rises, raising the cost of borrowing for consumers and businesses, it is difficult to imagine a way that the Fed would be able to avoid a recession.

David Kelly, chief global strategist at JPMorgan Asset Management, said the Fed’s move “increases the risk of a recession this year or early next year and clearly increases the risk that they will not be able to raise rates for long.” said on a conference call with reporters on Wednesday.

“I wouldn’t be surprised if within a year, we’re having a meeting where the Fed is considering cutting rates,” he said.

Unsurprisingly, stocks usually don’t do well during recessions. According to Deutsche Bank research, the S&P 500 has fallen an average of 24% during the recession going back to 1946.

“If we don’t see a recession, we are approaching peak territory,” Deutsche Bank strategist Jim Reid wrote in a note.

According to a Goldman Sachs analysis, the silver lining for investors is that, when the Fed began to move toward easing monetary policy, markets have historically reacted positively and bullishly — especially if the primary part of their slide. The reason was related to central-bank policy.

No one is sure exactly when the Fed will shift gears, and how much more pressure the economy could be facing in the meantime.

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

Write to Akane Otani at [email protected]

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