Stock market futures suggest a down opening for this new trading day. In the wake of the Federal Reserve’s meeting earlier this week, stocks are having difficulty finding firmer ground. On Wednesday, the Fed announced a third consecutive hike in short-term interest rates of 0.75 of a percentage point, bringing the overnight lending rate range for depository institutions (e.g., banks and credit unions) to 3.00%-3.25%. In a press conference, Chairman Jerome Powell reiterated the central bank’s intentions to aggressively fight inflation. Apparently, rate increases may well continue into 2023, and the cost of short-term borrowing could ultimately rise to the 4.6% mark. With real interest rates (nominal rates minus inflation) still negative, many market pundits are calling for interest levels above 5.0%. The major market indexes have moved lower on the latest news, and seem likely to post low-single-digit losses for all of this week.
Shortly, investors will get a read on the Standard & Poor’s flash PMI (Purchasing Managers’ Index) for both manufacturing and services for the month of September. Economists expect evidence of a further steady expansion in manufacturing and a contraction in the services sector, with the latter showing a month-to-month improvement. This afternoon, Chairman Powell will provide some additional remarks in a Fed event. Stock traders are sure to react to those remarks.
In yesterday’s trading, decliners outnumbered advancing stocks by a ratio of about 3-to-1. Technology issues led the down trend. We note that rising interest rates discount the future earnings and cash flows of companies, hitting growth stocks the hardest. The 10-year and two-year Treasury bond yields rose to multiyear highs of more than 3.7% and 4.1%, respectively, keeping the yield curve inverted. (An inverted curve suggests a looming recession.) Stocks under pressure included Advanced Micro Devices (AMD), NVIDIA (NVDA), American Express (AXP), and United Parcel Service (UPS). Underpinning the markets were shares of Merck & Co. (MRK), Eli Lilly & Co. (LLY), Johnson & Johnson (JNJ), and UnitedHealth Group (UNH).
The blue-chip Dow Jones Industrial Average, broader Standard & Poor’s 500, and the tech-heavy NASDAQ are now testing their respective mid-June lows. More investors are coming to terms with the central bank’s interest rate plan and are realizing that they cannot “fight the Fed,” as market strategists warn against. We’re cautiously optimistic that this year’s lows for stocks are already in, which is by no means certain. It’s easier to say with conviction that volatility will be elevated through the end of 2022. Inflation and the Fed’s rate hikes will take some time to wend their way through the economy over the next several months. There are signs that economic activity is slowing. The housing market is softening, and consumers are becoming more prudent about spending on goods and services. Corporate earnings look to weaken in the second half of this year. Valuations have again become more reasonable, making stocks attractive on a 3- to 5-year basis, but we don’t think there’s any need for investors to rush to recommit any cash reserves they may have to the market right now. We note that higher interest rates are beginning to make bonds a tempting alternative to equities.
– David M. Reimer
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
