Markets Best Keep Their Bullish Impulses in Check
In order for that to happen, investors would need to suppress their obsession with “buying the dip.” The S&P 500 Index is now 14 trading days and 9.2% into its fifth mini-drawdown of the year. The first four lasted from 10 to 36 trading days and zapped 9% to 16% off the benchmark’s value from peak to trough. So, this slump is already within the range at which a brief reversal is possible, if not necessarily imminent. Will traders poke the hornet’s nest before the Fed’s September 20-21 policy meeting?
Measures of financial conditions track more than just equities, but stocks have been the most visible source of defiance as the Fed has tried to curb demand to tame the highest rates of inflation in four decades. Monetary policy works in part through financial markets, as the combination of higher borrowing costs and lower asset prices make consumers and businesses less inclined to spend. Although the Fed doesn’t explicitly target financial conditions, members of the rate-setting Federal Open Market Committee keep a close eye on them: “I certainly was not excited to see the stock market rallying after our last Federal Open Market Committee meeting” in late July, Federal Reserve Bank of Minneapolis President Neel Kashkari told Bloomberg’s Odd Lots podcast last week.
Conditions have been heading in the Fed’s desired direction lately, helped along by a nudge from Powell. At his Aug. 26 speech in Jackson Hole, Wyoming, he made a point to push back against most of the bullish narratives that had been sustaining risk assets, arguing that even in the face of a slowing economy, the central bank had no intention to cut rates anytime soon. Federal funds futures now imply that the central bank will push the upper bound of the target rate to 4% by February from 2.50% currently, and even if it starts to reverse course, may only cut rates by a paltry 25 basis points in 2023. As for this month, the debate is centered on whether the Fed will raise rates by 50 basis points or 75 basis points. Futures imply a three-quarters likelihood the central bank will choose the latter.
Whether the Fed has tightened monetary policy enough depends on how you conceptualize financial conditions. Goldman Sachs Group Inc.’s GS US Financial Conditions Index has headed back toward the tightest levels of the year, helped by the increase in 10-year Treasury yields. On the other hand, Bloomberg’s United States Financial Conditions Index has tightened but remains much looser than early July. The Goldman Sachs index gives considerable weight to 10-year yields, while the Bloomberg index emphasizes credit spreads and ascribes more importance to stock-related components. Either way, the Fed has to like the trajectory.
It’s mostly technical drivers that could attract equity investors and potentially make Powell’s decision easy. In other words, stocks have gone down enough that there are bound to be some short-sellers who don’t want to leave their profits at risk and fast-money traders who see bargains. That doesn’t necessarily become a problem for the Fed unless the whole thing snowballs, as it did in July and August, and real money starts to see the rally as something more durable. What are the factors to watch? Here is a sampling:
• The 14-day relative strength index — a user-friendly momentum indicator that signals when assets and indexes may be “overbought” or “oversold” — is nearing the key level of 30 that indicates the latter.
• The S&P 500 has a “key support” level at around 3,900, as my Bloomberg Intelligence Chief Equity Strategist Gina Martin Adams and Senior Associate Analyst Gillian Wolff pointed out Friday. (This means that trading patterns suggest that some investors thought these levels were a good buy earlier in the year, so maybe they’ll feel that way again.)
• The CBOE equity put/call ratio, a measure of the ratio of bearish option market bets to bullish ones, is back near the highest since June. Taken as a contrarian indicator, the ratio indicates to some people that the gloom is overdone and a reversal may be near.
You may choose to believe these signals or not, but plenty of market participants do, which makes them relevant to the odds of a near-term bounce. What’s more, there simply isn’t a lot of top-tier fundamental data to trade until the crucial Consumer Price Index release on Sept. 13. Analysts may continue to tweak their earnings outlooks — Morgan Stanley just slashed its 2023 base-case for S&P 500 earnings per share by 10% to $212 — but there won’t be much in the way of concrete developments.
All told, much will come down to sentiment and a factor that’s even harder to predict: temerity. Certainly, a further moderation in inflation could help tip the scales in favor of a 50-basis-point rate increase, but there’s little sense in getting too excited about it beforehand. If the market really wants to see a measured Fed in September, it’s best to keep its bullishness in check.More From Bloomberg Opinion:
• Surging Dollar Is a Mixed Blessing for the US: Mohamed El-Erian
• Wall Street Is in Denial Over the ‘Real’ Economy: Gary Shilling
• The Fed Is About to Go Full Throttle on QT. Fear Not: Kevin Muir
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Jonathan Levin has worked as a Bloomberg journalist in Latin America and the U.S., covering finance, markets and M&A. Most recently, he has served as the company’s Miami bureau chief. He is a CFA charterholder.
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