- The S&P 500, the Nasdaq 100 and the Dow suffered heavy losses during the week after the Federal Reserve endorsed a hawkish monetary policy tightening path
- Recession fears, coupled with rising interest rates, will continue to depress risk appetite, preventing stocks form staging a meaningful comeback.
- Any rally attempt may bet met with strong selling interest in the near term
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U.S. stocks had a turbulent week amid soaring U.S. Treasury yields after the Federal Reserve delivered the third consecutive 75 basis points hike and signaled a steeper path of interest rate increases over the forecast horizon at its September FOMC meeting. Against this backdrop, the S&P 500 and Nasdaq 100 suffered heavy losses, but narrowly averted retesting their 2022 worst levels. The Dow, however, wasn’t so lucky and made a fresh lower low on Friday morning, briefly entering bear market territory.
The widespread narrative is that the Fed’s aggressive normalization cycle, coupled with its pledge to keep a restrictive stance for an extended period of time, will trigger a painful hard landing, a scenario that could severely undermine the outlook for corporate earnings.
While it is true that the U.S. economy is holding up better than expected, the market is forward-looking, implying that tomorrow’s events are more important than today’s developments. Another key point to keep in mind is that economic resilience, reflected in the strength of the labor market, only means that policymakers will have to slam on the breaks even harder to bring about the kind of demand destruction needed to knock inflation down and force it back to the 2.0% target.
S&P 500, NASDAQ 100 AND DOW CHART (WEEKLY PERFORMANCE)
There is another overhang for stocks: monetary policy acts with a long and variable lag. This principle suggests that the Fed’s actions of the past seven months have not yet fully played out in the real economy. When the tightening of financial conditions seeps more broadly into the system, its negative effects should become more visible.
Justified or not, investors seem to be preparing for an Armageddon of sorts by continuing to de-risk their portfolios, possibly ahead of large downside earnings revisions, with the next reporting period around the corner. The bearish sentiment will not fade any time soon; in fact, the mood could get worse before it gets better in the near term, exacerbated by the negative seasonal factors that tend to undermine equities in late September and October.
What does all this mean for the S&P 500, Nasdaq 100 and Dow Jones Industrial Average? From a fundamental standpoint, the path of least resistance appears to be lower for these indices, especially with nominal and real yields soaring to multi-year highs, which clearly obliterates the “TINA” argument for stocks that benefited equities during the period of record-low interest rates. While brief bear market rebounds cannot be ruled out, a sustained recovery seems difficult, with traders and speculators likely tempted to fade any rally attempt for now.
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—Written by Diego Colman, Market Strategist for DailyFX