During the first years of our career, nobody would ever have asked, “How much will the markets have to go down before the Fed will shift their monetary policy?” Back then, the thought that the Fed would think about anything other than the economy when forming their monetary policy was foreign to pretty much everybody. Needless to say, this has completely changed…especially over the past dozen years. The “Fed put” has been a dominant theme since the financial crisis…and even though we all realize that it is further “out-of-the-money” than it used to be, A LOT of people seem to believe that it’s not very far below where the market stands right now.
It is amazing to hear just how many people have expressed the view this week that the stock market is about to rally in a meaningful way. Once the Fed makes their announcement today, they say…and Chairman Powell gives his press conference…the stock market will begin a very strong rally. At least that’s what a log of people are now assuming as we write this morning. Some people believe it will mark THE bottom for this correction/bear market (correction for the S&P 500…bear market for the Nasdaq). Others believe it will be just a multi-week rally…that will be followed by more weakness (and maybe even lower-lows) later this year.
As you know, this latter argument is one that we had been following last week…and over this past weekend. However, since SO MANY people have now come to the same conclusion this week, we decided to rethink our stance. No, just because our scenario has become a consensus one is not why we’re adjusting our stance. (In fact, we are not completely changing our stance…we’re just adjusting it.) The fact that this scenario became such a popular one…so suddenly…merely made us step back and reconsider our stance. It caused us to go back and look at other examples of when the markets came under pressure due to the Fed’s policy…and THAT has led us to reconsider what will happen next in the stock market.
Don’t get us wrong, we have seen several examples of when the Fed’s change in policy caused the stock market to weaken in a pronounced way…AND they did indeed come to the rescue many of those times. (Their quick reversal after the end of QE2 stands at the top of that list.) However, there IS one example when the Fed did not shift their policy in reaction to the decline in the stock market. This took place in December of 2018. Back then, the S&P 500 stood 13% below its all-time highs (JUST LIKE it is today). However, despite that weakness, the Fed went ahead and raised short-term rates once again at that December 2018 meeting…and maintained a hawkish stance! It was not until a couple of weeks later…and a further 7% drop in the stock market…and (more importantly) a significant freezing up of the high yield market…that the Fed changed course.
What if the Fed takes the same tact this time around?.....Well, most people don’t think that will happen. Even many of those who believe the stock market will make lower-lows at some point later this year believe that the Fed does not want this decline to happen all at once. Instead, they believe that the Fed is trying to engage in policy that will cause a “2 steps back, 1 step forward, 2 steps back, 1 step forward, etc” kind of move in the markets this year.
To be honest, (like we said above) this is EXACTLY what we had been thinking until the beginning of this week. We’d also say that the odds are still quite good that this is indeed what will take place. However, given what the Fed did in December 2018…and given what Mr. Powell said at his most recent Congressional testimony (when he basically told Senator Shelby, “Let the record show that we will do whatever it takes to tame inflation”)…there IS a chance that we’ll get a “Volcker moment” today. There IS a chance that Chairman Powell not only raises rates, but remains quite hawkish in his guidance.
We admit that the odds that we will get an announcement and the kind of press conference that are hawkish enough to be called a “Volcker moment” are less than 50/50. However, we also think the odds are a lot higher than most people believe right now.
In other words, we do not have a strong conviction about the near-term potential for the stock market…except to say that there will very likely be a couple of big swings this afternoon (and maybe over the next couple of days)…in both directions…before we fully understand which direction the next big move will come.
Either way, the war in Ukraine means that the problem of inflation is going to be with us for a very long time. This means that the Fed WILL need to be aggressive in their tightening policy…even if they jawbone the situation in a more dovish way today. Their fight against inflation is going to cause more pain in the marketplace at some point in our opinion. Therefore, we believe that the stock market will make lower-lows as we go through the year. With this in mind, we believe that investors should continue to use rallies to raise cash and get more defensive…whether the next rally comes now…or after another sharp decline.
Matthew J. Maley
Chief Market Strategist
Miller Tabak + Co., LLC
Founder, The Maley Report
275 Grove St. Suite 2-400
Newton, MA 02466
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