The Stock Market Is Getting Hit by Higher Rates and Tumbling Banks. Why the Next Move Could Be Higher.

The damage first came from comments made by Federal Reserve Chairman Jerome Powell in testimony before the Senate. There, he said that inflation is very strong and that rates would need to go higher than the market expected, sending the prospect of a half-point interest rate hike to more than 80%. Then, SVB Financial Group (ticker: SIVB), the parent of Silicon Valley Bank, told investors that it was forced to sell securities at a loss due to dwindling deposits, sending the stock down more than 60%. was – and it took up the rest. Also the banking sector. As of Friday afternoon, the Silicon Valley bank was closed.

Investors have been waiting for something to break, and SVB’s collapse may be the first sign that things are falling apart. The fear is that other banks are having similar issues, which is why the SPDR S&P Bank Exchange-Traded Fund (KBE) dropped 17% this week. And if the Fed decides it needs to raise interest rates aggressively—the CME FedWatch tool now says it’s basically a coin flip whether rates go up a quarter or half a point at this month’s meeting— This is likely what will happen.

But it doesn’t need to play like this. Last Friday’s payroll report showed signs of a cooling job market, despite the headline number that showed 311,000 jobs were created. For example, the unemployment rate rose to 3.6%, while wages grew 0.2% at a slower rate than expected. And banking sector problems could make the Fed more likely to raise rates strongly higher, not less.

“Bank troubles may at least persuade Fed officials to slow the pace of tightening,” writes Ed Yardeni, president of Yardeni Research. ,[Monetary] The policy is already restrictive enough to engineer a soft landing and continued deflation.

And a soft landing — the idea that the Fed can ease inflation without sending the economy into a deep recession — is exactly what the stock market is in for. Payroll data suggests it may be closer to reality than investors give it credit for. If a recession is avoided, history shows that 4600 is a reasonable target for the S&P 500—even if earnings decline year after year, which is very believable.

In years without a recession but when the S&P 500’s earnings were declining, the index rose an average of 17%, according to Evercore data, with some years posting even better gains. For example, in 1998, a year with high volatility, the index rose by 27%. The midpoint of those moves, 22%, would propel the S&P 500 slightly above 4600 by the end of the year.

“A ‘soft landing’ playbook would suggest equity upside,” writes Julien Emanuel, chief equity and derivatives strategist at Evercore.

Is it too much to expect? wishful thinking? Something like an ostrich sticking its head in the sand? Perhaps. But fear often has a way of turning into something else.

“Once the fear is gone, greed can really drive this market higher,” Yardeni says. “I have no problem with the 4600 until the end of the year.”

We can hope.

write to Jacob Sonenshine at [email protected]