For equity investors sunk in gloom, the interest rate rise expected from the Federal Reserve on Wednesday may actually yield some relief.
US stock markets have been feeling the heat ahead of the Fed’s meeting, with the S&P 500 and the Nasdaq 100 Indexes falling 6.2% and 7% respectively over the past six days, on the outside chance Chairman Jerome Powell could adopt an even more hawkish stance to combat scorching inflation.
Yet if history is any guide, markets may be due a bounce once the meeting is done and dusted.
Over the past 18 months, the S&P 500 Index has risen after eight out of 10 Fed decisions. In the days following the Fed meetings in January, March and June, stocks rose between 6% and 9%, having dropped sharply in the run-up.
“Expectations are very hawkish, and the Fed can come out just as expected and still be more dovish than expected,” Brad McMillan, chief investment officer for Commonwealth Financial Network, said in emailed comments. “That likely limits the market downside from this meeting and just may provide some upside going forward.”
Wednesday is expected to bring the Fed’s fifth consecutive rate hike this year, taking benchmark borrowing costs to 3.25%. That has driven 10-year Treasury yields above 3.5%, the highest since 2011, forcing many investors to dump shares.
But the extreme bearish positioning could also prove to be a source of support for stocks. Fund managers are the most underweight equities they’ve ever been, while cash levels are at their highest level on record, according to Bank of America Corp’s latest monthly survey.
S&P 500 futures gained 0.3% by 7:04 a.m. in New York, while Nasdaq 100 contracts were little changed.
“There’s been so much speculation about the Fed’s next step that finally having a decision should provide some much needed relief for investors,” said Danni Hewson, financial analyst at AJ Bell. “If it sticks to script and delivers another 75 basis point hike markets are likely to rally somewhat, partly because the specter of a full percentage point rise didn’t come to pass.”
Another gauge, CFTC’s S&P 500 net non-commercial futures, also shows an extremely negative view, having reached levels last seen during the downturns of 2008, 2011, 2015 and 2020. Such bleak sentiment is often seen as a contrarian indicator, flagging a rebound.
“Robust earnings, low investor positioning and well anchored long-term inflation expectations should mitigate any downside in risk assets from here,” JPMorgan Chase & Co. strategists, led by Marko Kolanovic, said in a note on Monday.
Market technicals may also be flagging a bottom is near, especially on technology shares. The tech-heavy Nasdaq 100 has dropped 27% this year, and around 16% of its constituents currently trade just above their 200-day moving average.
Analysis shows this kind of depressed technical breadth has coincided with previous market bottoms — with the exception of 2008.
Not everyone is confident a rally is imminent. US equity valuations remain elevated compared with history and with previous economic downturns, keeping some investors wary of increasing exposure while the Fed continues to raise rates.
“We expect a policy overtightening that causes recessions,” Wei Li, global chief investment strategist for BlackRock Inc. said in a note on Monday. She has a tactical underweight stance on equities, because “recession risks still aren’t factored in.”
According to Nomura’s quant analyst Yoshitaka Suda, supply-demand dynamics among speculative investors are setting up US equities for more softness, with macro funds building up short positions right after the latest US inflation data. Macro funds “will stay to the short side in US equities at least until the release of employment data” on Oct. 7, Suda said in a note.
© 2022 Bloomberg L.P.