Historically, stocks don’t dip to their lowest levels until the Federal Reserve eases

Another week of low-curve stock trading, with many investors wondering how much other markets have fallen.

Investors have often blamed the Federal Reserve for market trajectories. It turns out that the Federal Reserve had a role in the market shifts, too. Back in 1950, the S&P 500 sold at least 15% on 17 occasions, according to research from Vickie Chang, global markets analyst at Goldman Sachs Group Inc. On 11 of those 17 occasions, the stock market only managed to bottom out just as the Fed turned toward easing monetary policy again.

Getting to this point can be painful. The S&P 500 plunged 23% in 2022, marking its worst start since 1932. The index fell 5.8% last week, its biggest drop since the pandemic-fuelled sell-off in March 2020.

The Fed has just started. After approving the largest interest rate hike since 1994 on Wednesday, the central bank indicated that it intends to raise interest rates several times this year so that it can curb inflation.

The tightening of monetary policy, along with inflation that is at its highest levels in four decades, has many investors fearing that the economy may enter a recession. Data on retail sales, consumer confidence, home construction and factory activity have shown significant weakness in recent weeks. And while corporate earnings are now solid, analysts expect they will come under pressure in the second half of the year. 417 Standard & Poor’s 500 companies reported inflation in their earnings calls for the first quarter, the highest number dating back to 2010, according to FactSet.

Next week, investors will analyze data including existing home sales, consumer confidence and new home sales to gauge the trajectory of the economy. US markets are closed on Monday watching Juneteenth.

Said David Donabedian, chief investment officer at CIBC Private Wealth of the United States.

Federal Reserve Chairman Jerome Powell on the screen of the New York Stock Exchange on Wednesday, when the central bank indicated that it intends to raise interest rates several times this year.


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Brendan McDermid/Reuters

the master. Donabedian said he discouraged clients from trying to “buy the dip,” or buy shares at a discount with the expectation that the market will soon improve. He said that even after a tough sell-off, the stock still didn’t look cheap. He added that the earnings outlook still looked very optimistic about the future.

The S&P 500 is trading at 15.4 times its forecast earnings for the next 12 months, according to FactSet, just below the 15-year average of 15.7. Analysts are still currently expecting the S&P 500 companies to report double-digit earnings growth in the third and fourth quarters, according to FactSet.

Other investors say they remain wary of the possibility that the Fed will have to act more aggressively, if policymakers are surprised by another unexpectedly high inflation reading. The University of Michigan consumer survey, released earlier this month, showed households expect inflation to be 3.3% five years from now, up from 3% in May. This is the first increase since January. Separately, the Labor Department’s Consumer Price Index rose 8.6% in May compared to the same month a year earlier, the fastest increase since 1981.

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“We feel that if the next inflation number is too high again, the Fed can [raise rates] “More sharply,” said Charles Henry Monshaw, chief investment officer at Syz Bank, in comments via email. He added that this could increase pressure on risky assets such as stocks.

When the Fed started raising interest rates again this year, it said it hoped for a soft landing, a scenario in which it slows the economy enough to curb inflation but not so much that it causes a recession.

In recent weeks, many investors and analysts have become increasingly pessimistic that the Fed will be able to achieve this. The data has already shown signs of slowing economic activity. Because higher interest rates increase the cost of borrowing for consumers and businesses, it is difficult to envision a way in which the Federal Reserve can avoid deflation, many analysts say.

The Fed’s moves “increase the risk of a recession starting this year or early next year and frankly raise the risk that they won’t be able to keep raising rates for long,” David Kelly, chief global strategist at JP Morgan Asset Management, told a cross-conference. Phone with reporters on Wednesday.

“I wouldn’t be surprised if in a year’s time we have a meeting where the Fed is considering cutting interest rates,” he added.

Unsurprisingly, stocks usually do not perform well during downturns. The S&P 500 has fallen an average of 24% during recessions dating back to 1946, according to research from Deutsche Bank.

“If we don’t see a recession, we are approaching extreme territory,” Jim Reed, strategist at Deutsche Bank, wrote in a note.

The silver lining for investors is that when the Fed begins to shift toward accommodative monetary policy, markets have historically responded positively and quickly — especially if the main reason for their slippage is related to central bank policy, according to a Goldman Sachs analysis.

What no one is sure of is when exactly the Fed will change its direction, and how much stress the economy may be exposed to in the meantime.

“I expect the summer to be very volatile,” said Nancy Tengler, chief investment officer at Laffer Tengler Investments.

Navigating a Bear Market

Write to Akane Otani at akane.otani@wsj.com

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