Wall Street balks as Fed signals party’s ending, but is it?

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Wall Street is concerned about the Federal Reserve withdrawing its massive support for financial markets

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Stock prices fell after Powell said the Fed could halt its immense support for financial markets sooner than Wall Street expected. However, history shows that stocks aren’t always the losers when the Fed withdraws its help.

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Some economists and investors were already calling for such a move, given the economy’s strong recovery from last year’s brief recession and the stubborn persistence of high inflation prevailing in the world.

But the S&P 500 sank 1.9% in one day after Powell said the Fed’s monthly purchase of bonds, which recently began shrinking by $120 billion, could end sooner than the June target for which It was on speed. Wall Street’s so-called “fear gauge” rose sharply as concerns about the new coronavirus spread around the world.

Wall Street has cause for concern. An early stop for the Fed’s bond-buying program, which has helped keep long-term interest rates low and thus supports the economy, for the central bank to make more effective decisions to raise short-term interest rates. will open the door.

They have been pinned to a record low near zero since the start of the pandemic, one of the key reasons the S&P 500 has nearly doubled since hitting a four-year low in March 2020. Low rates are also one of the main reasons many investors brush aside. There is concern that stock prices have climbed too, too fast.

For example, an investor buying 10-year Treasuries is looking at a yield of only 1.44%, not even taking into account current inflation levels.

“As long as the 10-year remains below 1.50%, there is no option to buy the stock,” said Josh Wayne, portfolio manager at Hennessy Funds.

To see how Wall Street has picked up, consider what investors are paying for every $1 of corporate earnings. According to FactSet, the price of the S&P 500 has been trading at close to 24 times the earnings per share of its companies over the past 12 months. That’s more expensive than its average price-income level of slightly less than 18 over the past two decades.

According to BofA Global Research, since 1983, the S&P 500 has delivered positive returns in the 12 months following the start of the rate-hike campaign in six out of seven events. The average return was 6.1%.

Extend the time horizon to two years after the first rate hike, and the S&P 500 still had positive returns in all but one of them.

According to Savita Subramaniam, equity strategist at BofA Securities, one exception to be sure is that the market has parity with today. In the midst of the dot-com bubble, the S&P 500 was much more expensive than usual in 1999, with S&P 500 prices trading at 30.5 times their earnings.

The historical record for the performance of US stocks when the Fed slowed its bond purchases is not as deep. That’s because such bond-buying programs have become only a regular part of the central bank’s toolbox since the 2008 financial crisis.

Stocks struggled slightly in the summer of 2013 when Fed Chair Ben Bernanke suggested it could slow down, or reduce its bond purchases. This took investors by surprise, and the upcoming mini-swoon for the market became known as the “taper tantrum.”

But the shares still recovered sharply. The Fed did not raise short-term interest rates until the end of 2015, more than two years after a taper tantrum.

“While some worry that the end of tapering accelerates the point at which interest rates rise, I do not believe that will happen, although this fear of higher rates plagues the market in the short term,” David Bansen, chief investment executive of the Bansen Group.

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