Markets are struggling to keep up with the focus on the Fed

After a stock rally this summer met with skepticism, investors are heading into the fall with a sense of dissatisfaction.

The Federal Reserve has vowed to raise interest rates aggressively to combat inflation, which remains near the highest in decades, and war in Europe and Covid-19 lockdowns in China are complicating efforts to predict how the economy will weather the pain.

Even seemingly good news is not enough to sustain a stock rally. Major indexes initially rose on Friday after the monthly jobs report walked the fine line of suggesting the economy remains strong while indicating wage pressures may ease.

But stocks later retreated in a volatile session that may have been exacerbated by light trading ahead of the Labor Day weekend. The mood shifted after Russia indefinitely suspended natural gas flows to Europe, heightening efforts as governments on the continent try to avoid energy shortages.

The S&P 500 lost 1.1%, ending a third straight week of declines, with the index down 8.3%. This is a decrease of 18% in 2022.

Between the central bank’s fight against inflation and economic pressures abroad, many investors say it’s not hard to find reasons to feel bearish.

“Of course we are still hiking [rates] at a very rapid pace,” said Tiffany Wade, senior portfolio manager at Columbia Threadneedle Investments. What’s more, she said, “There are a lot of negative factors going on around the world that could affect the markets over the next several quarters.”

The markets have been struggling to walk a tightrope lately. With investors focused on the Fed’s campaign to tame inflation, stocks slipped as strong economic data suggested the central bank may need to raise interest rates more aggressively to cool the economy.

But as monetary tightening takes time to trickle down, analysts have also braced for the possibility that economic data will at some point show the kind of weakness that comes with a recession.

Friday’s jobs numbers appeared to hit the sweet spot.

The report showed that monthly wage growth slowed in August, a positive sign as investors and policymakers watch for inflation to ease. U.S. employers added 315,000 jobs, suggesting the economy remains robust and broadly matching forecasts from economists polled by The Wall Street Journal.

The Fed’s commitment to reining in inflation, which has remained close to a four-decade high, has shaped a relationship that could seem unfathomable to the world outside Wall Street: Data signaling economic strength has been received as bad news of the stock market as it could convince the Fed that more big rate hikes are needed to cool the economy enough to slow the cycle of price increases.

Last week, for example, the S&P 500 fell 1.1% on Tuesday after data showed job openings rose in July, another marker of a tight labor market, with demand for workers outstripping the number of unemployed looking for work. And on Thursday, stocks initially traded lower after a survey of US manufacturing activity came in stronger than expected.

“In general, we’re probably in a period where good news is taken poorly by the markets,” Ms. Wade. “As long as the economy still continues to be strong, that gives the Fed cover to raise interest rates more to fight inflation faster.”

Investors this week will analyze data assessing the services side of the economy as well as new jobless claims figures as they anticipate the next meeting of the central bank’s interest rate committee later in September.

Traders on Friday bet there was a better than 50-50 chance the Fed would raise interest rates by 0.75 percentage point at that meeting, although bets on a smaller 0.5 percentage point increase rose after the jobs report, according to data from the CME Group.

Since Fed Chairman Jerome Powell reiterated the central bank’s stance on inflation in a speech on August 26, markets have taken a cautious tone.

Utilities, grocery stocks and health care stocks, groups that tend to hold up relatively well when economic growth weakens, are among the best-performing S&P 500 sectors since the day before his remarks. Shares in Cardinal Health Inc.,

tool Consolidated Edison Inc.

and Cheerios cereal maker General Mills Inc.

all outperformed the market during that time.

Technology stocks, which often trade at high valuations that make them particularly sensitive to rising rates, were the worst-performing S&P 500 segment during the same period. Shares in Salesforce Inc.

and Qualcomm Inc.

are each down 12% since August 25.

Even after the downturn this year, the stock market is generally priced at levels that many investors don’t see as an enticing trade. The S&P 500 traded at the end of last week at 16.9 times its expected earnings over the next 12 months, down from 21.5 where it closed last year, but just a touch below the 10-year average of about 17, 2 according to FactSet.

“We’re at a pretty treacherous point right now,” said Brian Jacobsen, senior investment strategist at Allspring Global Investments. Even with lower valuations, he said, “They’re not that attractive, where it looks like people have just given up on stocks and really hit the peak of pessimism.”

Jeremy Zirin, senior portfolio manager and head of private client US equities at UBS Asset Management,

said his team has been buying stocks in health and consumer products in recent months.

Mr. Zirin believes that the view that good news is bad for stocks is too simplistic. In reality, he said, it’s all about inflation, which leaves a pretty narrow path for the market.

“If good growth data suggests that inflation will remain high, that will most likely be negative for the markets,” he said. “If inflation is falling because demand is falling rapidly and we’re heading into a recession, that’s not good news either.”

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