Will the Federal Reserve wipe out the upswing in stock markets? – Market observation | Eurica Project

A summer rebound raises hopes that the bear market in US stocks has bottomed, but a meeting of Federal Reserve policymakers next week could test the nerves of would-be bulls.

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

Disappointing results from social media platform Snap Inc. SNAP,
-39.08%
trimmed a weekly rise in shares on Friday, but benchmark indices still posted healthy gains. The S&P 500 SPX,
-0.93%
up 2.6% over the past week to end near 3,962 after breaking above 4,000 for the first time since June 9 early Friday. The Dow Jones Industrial Average DJIA,
-0.43%
posted a 2% weekly gain while the Nasdaq Composite COMP,
-1.87%
3.3% preferred.

This week’s rebound lifted indices off the 2022 lows after the S&P 500 slipped to a close of 3,666.67 on June 16.

See: Has the stock market bottomed out? What the pros are saying after the S&P 500 tests 4,000

The rebound was fueled in part by a momentum in which investors are treating bad news on the economic front as good news for stocks, James Reilly, an economist at Capital Economics, said in a note on Friday.

That may sound strange, but it probably reflects in part investors’ view that weaker economic data will prompt the Fed to hike rates less than previously thought, Reilly wrote. There is evidence of this in market-based expectations for rate hikes, which have been scaled back recently (see chart below), a development that has supported equity valuations, he said.

capital economics

Market expectations are for the Fed to deliver a 75 basis point rate hike on Wednesday, matching June’s hike, which was the largest since 2002.

Read: The Fed could get lucky or it 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 US Services Purchasing Managers’ Index fell to a 26-month low of 47 in July from 51.6 in the previous month, based on a “Flash” poll by S&P Global Market Intelligence. A reading of less than 50 signals a contraction in activity.

On Thursday, weekly jobless claims rose to their highest since November but remained at historic lows, the Philadelphia Fed Manufacturing Index unexpectedly slipped deeper into negative territory and the Conference Board said its leading economic index showed a U.S. recession towards the end of the year and early next is now likely.

US economic data, due next week, includes a first estimate of second-quarter gross domestic product, which is expected to contract for a second straight month. While such an outcome is often referred to as a technical recession, a still-strong job market and other factors make it unlikely that the National Bureau of Economic Research, the official arbiter of the business cycle, will declare one.

Related: A ‘fake’ recession? Despite the weak GDP, the US economy is in good shape for the time being

Reilly said he doubts slowing activity will slow the Fed’s role.

“Our key forecast is that US economic growth will remain weak, but not so weak that it could deter the Fed from aggressively raising interest rates for the remainder of this year. Such an outcome would likely mean rising discount rates and disappointing corporate earnings growth, which would be a rather toxic combination for stock prices,” he wrote.

Many Fed watchers, including some former policymakers, see the Fed as intent on convincing market participants of their desire to wipe out inflation.

Former Richmond Fed President Jeffrey Lacker said on Friday that policymakers would need to keep raising interest rates even in the event of a recession. “Taking your foot off the brake before inflation has come down” is just “a recipe for another recession in the future,” Lacker said in an interview with Bloomberg Television.

Even if the economy were to slow down fast enough to cause Fed policymakers to backtrack, it probably wouldn’t be good news for stocks, Reilly argued. That’s because corporate earnings would weaken further than the company already expects, he said. It’s also unlikely that support stocks, seen on the back of falling Fed Funds rate expectations, would persist in a sharp deceleration as history shows that valuations have tended to fall during such periods when risk appetite has eased Has.

But Goodwin said there was more to the stock market’s recent resilience.

“The market, on average, was expecting a tougher earnings season than before,” she said, acknowledging that the forecast was even more optimistic, she said, acknowledging it was just the beginning.

As of Friday morning, 75.5% of S&P 500 companies that reported had beaten consensus analyst forecasts for earnings per share. According to the I/B/E/S data provided by Refinitiv, the average was around 4.7%. This compares to 66% of companies that have beaten EPS estimates in a typical quarter since 1994 and an average profit margin of 9.5% over the previous four quarters.

For revenue, 68.9% of companies exceeded guidance by an average of about 1.3%, compared to 62% of companies growing in a typical quarter since 2002 and an average exceedance rate of 3.4% over the previous four quarters .

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

Markets have been dominated by worries about scorching inflation and the threat of a recession, so a “slightly more optimistic” reading from companies has been a dose of good news so far, Goodwin said.

Indeed, investors appeared to be vacillating between fears of inflation and fears of recession, market watchers said. In the first half of 2022, scorching inflation was the dominant concern as stocks plummeted and government bond yields soared. More recently, market movements suggest that investors have become more focused on the prospect of a recession as the Fed aggressively tightens policy.

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

Goodwin said inflation will remain a primary consideration in portfolio positioning as recession-resistant assets that have worked over the past cycle, such as cash, government bonds and high-quality corporate bonds, can significantly hamper wealth accumulation.

To cope with expected volatility, New York Life’s quality within asset classes is improving. For example, it is heavily overweight high yield in its portfolios as the corporate environment is expected to remain fairly resilient, she said, but quality within high yield is improving.

With consumer prices soaring, that also means looking at stocks and fixed income, which have cash flows linked to inflation, she said.

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