From a certain point onwards there is no turning back. The stock market reached that point last week.
Oh, the market was hopeful going into the week that inflation had peaked, that the Federal Reserve would soon stop raising interest rates, that the bottom was in. But Tuesday’s release of August consumer price index data showed that inflation had not been tamed and crushed all goodwill, sending the major indexes to their worst day since 2020.
(ticker: FDX) decided to tell investors — a week early, mind you — that its earnings were terrible and that it was withdrawing its full-year guidance. All this happened the week before the Fed meets to discuss its next rate hike, which is likely to be another 0.75 percentage points.
There is no avoiding, now, what is coming and the stock market knows it. That
Dow Jones Industrial Average
fell 4.1% for the week, while
the index fell 4.8% and
decreased by 5.5 per cent
“Investors are facing the reality that the Fed has more work to do and recession risk is high,” said Dave Donabedian, chief investment officer at CIBC Private Wealth US. “We’re not talking about putting more money to work in the stock markets. We’re preaching patience.”
It seems to go against the maxim that it often pays to be optimistic when everyone is anticipating the worst. Sundial Capital Research’s Jason Goepfert notes that fewer than 1% of S&P 500 stocks finished higher Tuesday, something that has happened only 28 other times since 1940. The index gained an average of 15.6% over the trailing 12 months, and was higher 79 % of the time.
So is this a buying opportunity?
Not so fast. Sometimes the market can get “super-oversold,” notes Doug Ramsey, chief investment officer at Leuthold Group. It may be a prelude to further declines, as was the case in 1998 before long-term asset management collapsed; in 1987, before Black Monday; and prior to the worst bear market sell-offs of 1973-74. “Oversold conditions have preceded most of the market’s worst short-term collapses,” explains Ramsey.
The chances of one are increasing. The Fed seems hell-bent on getting inflation under control, and that could mean interest rates go much higher. Where investors once worried about a terminal rate of 3.5%, they are now talking about 4% or even 5%. And once the Fed gets there, it will likely stay there rather than start cutting rates right away.
Still, bear markets usually don’t end — and bull markets don’t start — until the Fed begins to ease, according to Ed Clissold, chief strategist at Ned Davis Research, and sometimes only after the second rate cut. When a bear market ends before the Fed finishes raising interest rates, another bear market usually occurs. “History argues that the tightening cycle will inflict more pain on the stock market,” Clissold writes.
Even if it turns out to be wrong, this is no time to be a hero. Nordea Asset Management strategist Sebastien Galy notes that investors should try to identify companies that are “attractively valued solutions with lower downside risk that are resilient across a diversity of scenarios and styles,” a long way of saying quality stocks. “What we can strive for is to manage these complex risks and start positioning the next few quarters for the right valuation,” he concludes.
Or just wait it out.
Write to Ben Levisohn at Ben.Levisohn@barrons.com