The Federal Reserve’s determination to raise interest rates until it squashes the highest inflation in decades has darkened the outlook across Wall Street, as US stocks are at the peak of a bear market and recession warnings are mounting.
The issue is the so-called Fed Put, or the belief of investors that the Fed will take action if stocks fall too deep, even though there is no order to maintain the value of the assets. A frequently cited example of the incident is the name given to hedging derivatives used to protect the market from collapse, when the Fed closed a rate hiking cycle in early 2019 after a stock market conflict.
At this point, the Fed’s insistence that it will raise rates as high as needed to control rising inflation reinforces the argument that policymakers will be less sensitive to market volatility – a more painful threat to investors.
A recent survey by BofA Global Research found that fund managers will now jump to 3,529 in the Fed’s S&P 500, compared to expectations of 3,700 in February. Such a drop would constitute a 26% fall from the S&P closing high on January 3.
The index, which closed at 3,901.36 on Friday, has already fallen nearly 19% from this year’s high on an intraday basis – close to a 20% fall that would ensure a bear market, according to some definitions.
“The Fed has big fish to fry and that is the problem with inflation,” said Phil Orlando, chief equity market strategist at Federated Hermes, which is increasing its cash flow. “The ‘Fed Put’ is cut off until the central bank is confident that they are no longer behind the curve.”
As a result, some investors are digging into the long slogan. BofA’s survey shows cash allocations are at a two-decade high, with bets against technology stocks being the highest since 2006.
Goldman Sachs strategists, meanwhile, released a “Recession Manual for US Equities” earlier this week in response to client inquiries about how stocks would work in a recession. Analysts at Barclays say that a number of negative near-term catalysts mean that stocks are “firmly stacked downside.”
The S&P 500 closed broadly unchanged on Friday, reversing a sharp intraday fall that briefly put it in bear market territory. The index marked the seventh week of its losses, the longest since 2001.
Jason England, Janus Henderson Investors’ global bond portfolio manager, believes the Fed’s austerity measures need to reduce the index by at least another 15% because unprecedented monetary policy support has helped the stock more than double its March 2020 low.
“The Fed is very clear that there will be some pain ahead,” he said.
The Fed has already raised 75 basis points and is expected to tighten monetary policy by 193 basis points this year. Investors will have more insight into the central bank’s thinking when the minutes of the last meeting on May 25 are released.
Some are concerned that the Fed could exacerbate the volatility if it does not heed signs of potential danger from asset prices. Analysts at the Institute of International Finance say stocks could be subject to a similar sell-off in late 2018, when many investors believed the Fed had tightened monetary policy.
“In the past, growing uncertainty and growing recession risks have had a significant impact on investor psychology, making markets less tolerant of monetary policy tightening that is no longer certain,” IIF analysts wrote on Thursday. “The risk of similar market volatility (from 2018) is now rising again as markets are concerned about the global recession.”
There are signs of resilience among investors. For example, the Cboe volatility index, known as the Wall Street Fear Measure, has been higher but below the level it reached during previous major sales.
And the ARK Innovation Fund, which has become a symbol of the epidemic, has brought in $ 977 million in net positive flows over the past six weeks, Lipper data showed. In 2022 the fund is reduced by 57%.
While some investors say this is a sign that the market is still down, others are more optimistic.
Terry Spath, chief investment officer at Zuma Wealth, believes that some investors are re-entering parts of the stock market that have suffered major losses.
“The Fed is already seeing signs that they will not be needed as a last resort buyer,” he said.
Deutsche Bank analysts are less optimistic
“The Fed has made a bad mistake in terms of excess inflation in 2020/21, unable to make the same mistake twice – in favor of further tightening of the financial situation, and the ongoing high (volatile) panic market,” they wrote.