Equity Investors are Conditioned to Read the Fed as Dovish
The #equitymarket is up 14% from its June 16th low but the move is hard to justify. On a fundamental basis, there is increasing data showing the US and global economy are deteriorating while the geopolitical situation is still very unstable. Most importantly perhaps, Market participants seem to have a bias in reading Fed's statements as overly dovish.
The #equitymarket is up 14% from its June 16th low but the move is hard to justify. On a fundamental basis, there is increasing data showing the US and global economy are deteriorating while the geopolitical situation is still very unstable. The current stagflationary regime, the combination of obdurate inflation and lagging growth, doesn’t bode well for companies’ earnings going forward with #PEratio still far above the long term average. Technicals are also not supportive as the market, on an RSI basis, is the most overbought since October last year. Most importantly perhaps, the key evidence pointing to a bear market rally rather than a more sustainable uptrend, is sentiment; we have yet to see the kind of capitulation that is typically associated with a long term bottom as opined here:https://lnkd.in/gUJwp4bB.
Market participants seem to have a bias in reading Fed’s statements as overly dovish. In fact every statement following the FOMC meeting this year has been met with rising equity prices only for the declining trend to resume after a few days (see chart). Almost two decades of Fed action being supportive of asset prices seem to have engendered some kind of pavlovian response to “buy the dip” based on the assumption that any Fed communique marks the end of the decline. There is little question the Fed will need to flip from tightening to neutral, there is simply too much debt in the US and globally for Powell to “play” Volker. Yet, given the nature and extent of the inflationary pressure, it is hard to imagine the Fed being done or starting to meaningfully ease again as soon as the market expects.
On the contrary, last weeks’ rally is likely to strengthen the resolve of the Fed to inflict more pain on investors. The Fed needs to contrast inflation by curtailing economic activity. That can be done by actual credit tightening and through negative wealth effect, i.e. depressing asset prices. The political implications of the two options are profoundly different. For the latter they disproportionately affect only the most asset-rich part of the population, while for the former the political collateral damage is far wider as it also affects the more vulnerable part of the population. Hence the interest for the Fed to maximize negative wealth effect so as to minimize the actual tightening and therefore the risk of unsavory credit events.
On a fundamental, technical and sentiment basis, the bottom for equities is likely to be ahead rather than behind. Rather than FOMO-ing into the market, cognizant investors may want to look at the rally as an opportunity to make cash and rebalance their portfolios ahead of more decline in the weeks and months ahead. Disclosure: Hold all assets mentioned. Not investment advice. Do your own research.
#investing #equities #inflation