Ever since the S&P 500 reached its 200-day moving average (MA) one month ago, it’s been a rough stretch for investors.
Recently, things haven’t gotten any better.
Let’s start with the latest Consumer Price Index (CPI) report…
Last week, the CPI revealed that core inflation increased by more than expected in August.
Since the core index strips out food and energy prices – which are subject to short-term whipsaws – it’s a sign that inflationary pressures are becoming more entrenched.
But economists and investors were hoping for the exact opposite…
That’s because the CPI report reinforces that outsized interest rate hikes are still in the pipeline… Likely including another one today as the Fed wraps up another meeting.
It also means that rising interest rates – the main catalyst behind this bear market in stocks – aren’t going away any time soon.
Higher rates drag on stocks in two ways:
It makes the return on fixed income investments (like bonds) more attractive, thereby drawing funds away from equities.
Rising interest rates put the brakes on economic activity, which slows corporate earnings (like FedEx’s profit warning last week).
That’s why the stock market shed over 4% the day of the inflation report, as investors screamed in horror.
Yet, Federal Reserve Chairman Jerome Powell will keep ignoring the stock market’s cry for mercy over rate hikes.
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The Fed Will Break Something
There’s a critical link between interest rates and the broader economy you don’t hear discussed very often – financial conditions.
Think of financial conditions as the availability of cheap and plentiful credit, or lack thereof. When conditions are “loose,” it means funds are plentiful and cheap. That’s high octane fuel for stimulating the economy.
But when conditions get “tight,” it can extinguish demand for goods quickly.
For example, the housing market has quickly gone from red hot to struggling as more expensive interest rates squash demand.
Single-family housing starts have plunged by 23% since the start of the year.
Officials at the Fed are well aware of this link between financial conditions and economic activity.
In fact, Fed Chair Powell stated that the central bank would consider moving more aggressively to tighten financial conditions and tame inflation.
Now here’s the thing investors don’t want to hear… Despite multiple rounds of aggressive rate hikes, financial conditions are still looser than average!
You can see that in the chart below, which is a measure of financial conditions from the Fed’s very own Chicago district…
This is their own in-house indicator, with the solid black line representing the long-term average. Anything under that line indicates that conditions are looser than average, and tighter when above.
If you’re looking for a Fed pivot, don’t hold your breath until conditions have tightened much further. Or until something breaks in the capital markets because of it.
As a trader, that means you shouldn’t lose sight of the big picture backdrop – we’re stuck in a bear market until there are signs that the Fed will relent on interest rate hikes.
So, staying tactical and adaptive in your approach is paramount to navigating this stock market.
Analyst, Market Minute
Under what conditions do you think the Fed will reduce the interest rate hikes?
Let us know your thoughts – and any questions you have – at [email protected].