The US stock market most often bottoms out during collapses and begins to rise only when the Federal Reserve System (FRS) starts lowering interest rates, historical data over the past 70 years show.
The S&P 500 index has fallen by more than 15% 17 times since 1950, notes Goldman Sachs (NYSE:GS) analyst Vicki Chang. And in 11 out of 17 such cases, the index reversal towards growth occurred at about the same time as the beginning of the easing of the Fed’s monetary policy, she added.
“This is sad news for investors, writes The Wall Street Journal, as the Fed has just started raising rates to combat inflation. It is expected that the rate will be raised several more times this year and several times next year.”
The S&P 500 index has fallen by 23% since the beginning of January, which is the worst dynamics in 90 years. Over the past week alone, the indicator has lost 5.8%, showing a record drop since March 2020, when global markets reacted sharply to the outbreak of the coronavirus pandemic.
High inflation combined with rising rates increases fears of a recession in the world’s largest economy, the WSJ notes. Such concerns are confirmed in the latest statistical data, which indicated a weakening of retail sales, consumer sentiment, housing construction and activity in the industrial sector.
“I don’t think the market will continue to fall at the same rate, but it’s also hard to believe that we are approaching the bottom,” said David Donabedian, investment director at CIBC Private Wealth US.
He noted that he does not advise clients to buy shares in the expectation of their imminent rebound. In his opinion, American companies are still expensive, and forecasts regarding their profits are too optimistic.
The capitalization of companies included in the calculation of the S&P 500 index is 15.4 times higher than their expected profit in the next 12 months, according to FactSet. That is, the multiplier is now only slightly lower than the average for the last 15 years, which is 15.7x. At the same time, analysts expect that the profit growth of companies from the index will exceed 10% on average in the 3rd and 4th quarters.
At the same time, investors fear that inflation will remain high and the Fed will have to accelerate the pace of rate hikes.
“We believe that if the inflation rate remains very high, the Fed may make an even sharper rate hike,” wrote Charles-Henry Monchau, investment director at Syz Bank, adding that this will increase pressure on risky assets in general and stocks in particular.
The Fed’s actions increase the risks of a recession in the US this year or early next year, according to J.P. Morgan Asset Management analyst David Kelly. In turn, this may mean that the monetary policy tightening cycle will be short.
“It would not surprise me if the Fed holds a meeting during the year at which it will consider the possibility of a rate cut,” he added.
Since the beginning of the year, the US S&P500 index has already fallen by 23%, the NASDAQ by 32%, and the Dow Jones index by 18%. However, Edward Yardeni believes that stock markets have not yet reached the bottom, the newspaper writes. He does not think that the markets will get out of this situation very quickly, at least in a fundamental sense. In his opinion, the collapse of the markets will continue until there are clear signs that inflation caused by rising food and energy prices has reached its peak.
This year, US inflation has soared to new highs in 40 years, and the Fed, acting as the country’s central bank, raised interest rates by 75 basis points last week. The rate immediately increased by 0.75 percentage points for the first time in 28 years. The regulator also signaled the continuation of tightening monetary policy in order to curb inflation. Fed Chairman Jerome Powell said that at the next meeting in July, another increase of 50 or 75 bps is likely.
According to Yardeni, the idea of “never fight the Fed” has been present in the markets for a long time. It was that if the Fed is going to pursue a soft monetary policy, then you need to bet on the growth of stocks. This year, the US regulator began to raise rates. “I think investors have learned a lesson this year — ‘don’t fight the Fed,'” he said. “But what has changed dramatically this year is that ‘not fighting the Fed’ now means not fighting the Fed when it is fighting inflation. And that means it’s not a good environment for stocks in the short term.”