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As bear market looms, battered Wall St seeks elusive 'Fed put'

Economy May 22, 2022 06:00AM ET
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© Reuters. FILE PHOTO: Traders work on the floor of the New York Stock Exchange (NYSE) in New York City, U.S., March 21, 2022. REUTERS/Brendan McDermid

By David Randall

NEW YORK (Reuters) -The Federal Reserve's determination to raise interest rates until it squashes the highest inflation in decades is darkening the outlook across Wall Street, as U.S. stocks stand on the cusp of a bear market and warnings of a recession grow louder.

At issue is the so-called Fed put, or investors’ belief that the Fed will take action if stocks fall too deeply, even though it has no mandate to maintain asset prices. One oft-cited example of the phenomenon, which is named after a hedging derivative used to protect against market falls, occurred when the Fed halted a rate hiking cycle in early 2019 after a stock market tantrum.

This time around, the Fed’s insistence that it will raise rates as high as needed to tame surging inflation has bolstered the argument that policymakers will be less sensitive to market volatility - threatening more pain for investors.

A recent survey by BofA Global Research showed fund managers now expect the Fed to step in at 3,529 on the S&P 500, compared with expectations of 3,700 in February. Such a drop would constitute a 26% decline from the S&P’s Jan. 3 closing high.

The index, which closed Friday at 3,901.36, is already down almost 19% from that high this year on an intraday basis - close to the 20% decline that would confirm a bear market, according to some definitions. [.N]

"The Fed has bigger fish to fry and that's the inflation problem," said Phil Orlando, chief equity market strategist at Federated Hermes (NYSE:FHI), who is increasing his cash levels. "The 'Fed put' is kaput until the central bank is confident that they're no longer behind the curve."

As a result, some investors are digging in for a long slog. BofA’s survey showed cash allocations at a two-decade high, while bets against technology stocks stand at their highest since 2006.

Strategists at Goldman Sachs (NYSE:GS), meanwhile, earlier this week published a “Recession manual for US equities” in response to client inquiries on how stocks will perform in a downturn. Barclays (LON:BARC) analysts said that numerous negative near-term catalysts mean the risks for stocks “remain firmly stacked to the downside."

The S&P 500 closed broadly unchanged on Friday, reversing a sharp intraday decline that had briefly put it into bear market territory. The index marked its seventh straight week of losses, the longest streak since 2001.

Jason England, global bonds portfolio manager at Janus Henderson Investors, believes the index needs to fall at least another 15% for the Fed to slow its tightening, given that unprecedented monetary policy support helped stocks more than double from their March 2020 lows.

"The Fed is being very clear that there will be some pain ahead," he said.

The Fed has already raised rates by 75 basis points and is expected to tighten monetary policy by 193 basis points this year. [/FEDWATCH] Investors will get more insight into the central bank's thinking when minutes from its last meeting are released on May 25.

2018 REDUX?

Some worry the Fed risks exacerbating volatility if it does not heed possible danger signs from asset prices. Analysts at the Institute of International Finance said stocks may be subject to the same type of selling that rocked markets in late 2018, when many investors believed the Fed tightened monetary policy too far.

“In the past, rising uncertainty and mounting recession risk have had important effects on investor psychology, making markets less tolerant of monetary policy tightening that is seen as no longer warranted,” IIF analysts wrote on Thursday. “The risk of a similar market tantrum (to 2018) is rising again now as markets fret about global recession.”

There have been signs of resilient sentiment among investors. For example, the Cboe Volatility Index, known as Wall Street’s fear gauge, is elevated but below levels it reached during previous major selloffs.

And the ARK Innovation Fund (ARKK.K), which became emblematic of the pandemic rally, has brought in net positive inflows of $977 million over the last six weeks, Lipper data showed. The fund is down 57% in 2022.

While some investors say those are signals that markets are yet to bottom, others are more hopeful.

Terri Spath, chief investment officer at Zuma Wealth, believes some investors are re-entering parts of the stock market that have suffered outsized losses.

"The Fed is already seeing signs that they won't be needed as a buyer of last resort," she said.

Analysts at Deutsche Bank (ETR:DBKGn) are less optimistic.

"The Fed having badly erred on the side of excess inflation in 2020/21, cannot afford to make the same mistake twice - which favors more financial conditions tightening, and ongoing high (volatility) panicky markets," they wrote.

As bear market looms, battered Wall St seeks elusive 'Fed put'
 

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Comments (5)
John Healy
John Healy May 22, 2022 9:19AM ET
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I’m not sure how any if this can come as a surprise. The obscenely loose monetary and fiscal policies of the last 14 years have been writing a story that could only end in one of two ways; inflation or recession. It’s time we quit chasing the dragon and take our comeuppance so we can get back to a more sound economy instead of trying to borrow our way to prosperity. Equities have gotten fat on a diet of excessive liquidity that’s been almost free for the taking. This economy needs to lean out for the sake of its health or it’ll likely suffer a more catastrophic collapse.
Brad Albright
Brad Albright May 22, 2022 9:19AM ET
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Very astute.
HelliumStar ..
HelliumStar .. May 22, 2022 9:19AM ET
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This phenomenon is called cycled economy in plain macroeconomic languages. When the inflation is too high and unemployment is near zero percent the only way for monetary architects is to lift basics FED interest... To make libra in balance...
Santosh Oak
Santosh Oak May 22, 2022 7:31AM ET
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Let the stocks crash by another twenty percent at least. Stock prices are obscenely high, as are commodity prices. The latter should be thirty percent lower.
Chris Castaldo
Chris Castaldo May 22, 2022 7:31AM ET
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All asset classes are not supposed to be inflated at same time. We are in a bubble. Oil, energy, precious metals, commodities and equities. Too much money in the system.
CT OREN
CT OREN May 22, 2022 7:05AM ET
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I dont understand. Why save the stock market? Just let the market to collapse. We want a market meltdown like the month of March 2020.
Samuel Miller
Samuel Miller May 22, 2022 7:05AM ET
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A market meltdown might prevent me from retiring into an assisted living facility, where leases are expensive. I'm 65 and was born with cerebral palsy.
Joe Rizzuto
Joe Rizzuto May 22, 2022 6:51AM ET
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wake up! in terms of market reactions we are ALREADY in a WORST situation then the 2018 fed hiking cycle.
gab nea
gab nea May 22, 2022 6:38AM ET
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if the rich 1% own 70% of all stocks, when the fed lowers interest rates and the market explodes he is helping the 1%. he only works for the richest? it's only when helping the rich 1% causes inflation havoc causes dire straights for 99% then he steps in to destroy markets, after the 99% is pummeled. who exactly does he work for? and why did he help the rich so much and cause this?
Joe Rizzuto
Joe Rizzuto May 22, 2022 6:38AM ET
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that is among the most ignorant and incoherent comments ever posted on capitalism.com
 
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