After months of beating, the S&P 500 posted its best weekly gain since November 2020, as investors cheered for more clarity on monetary policy and an encouraging assessment of the US economy by the Fed. The gain has cut the index’s losses by nearly half so far, although it is still down 6.7% for 2022 after slipping into a correction last month.
Whether you want to get on board the rally is a thorny question in a market that continues to be fraught with risks — chief among these being the aggressive rate-raising path the Fed unveiled on Wednesday and geopolitical uncertainty over Russia’s invasion of Ukraine.
Still, some major banks think the worst is over for now. Strategists at UBS Global Wealth Management said on Friday that the expected pace of Fed tightening is “consistent with rising stocks” and advised clients to continue investing in stocks.
Earlier in the week, JPMorgan forecast that the S&P 500 would end the year at 4,900, about 10% above Friday’s close, and said markets “have now approved the much-anticipated launch of the Fed on what is probably the most perilous policy possible.”
Others are less optimistic. Concerns that the Fed’s fight against inflation could hamper growth was evident in the bond market, where a flattening yield curve accelerated after the Fed’s policy meeting this week. An inverted yield curve, in which short-term government bond yields are higher than longer-term yields, is a reliable predictor of past recessions.
Persistent inflation, skyrocketing commodity prices and little sign of an end to the war in Ukraine further obscure the picture for investors, said Rick Meckler, partner at Cherry Lane Investments.
“The markets are now getting more complicated by interest rates, they’re getting more complicated by inflation, and they’re definitely more complicated by the Russian situation,” he said. “You had a lot of people this week who thought we had bottomed out, but it’s hard to have higher and higher prices just based on that.”
Many also believe that the week’s sharp gains in stocks are unlikely to allay the economic concerns that fueled bearish sentiment in recent months.
Fund managers’ allocation to treasury is at its highest level since April 2020, according to BofA Global Research’s monthly survey. Bearish sentiment among retail investors is close to 50%, the latest survey from the American Association of Individual Investors found, well above the historic average of 30.5%.
“What we’re most concerned about right now…is really whether we’re going to hit a recession or not,” said King Lip, chief strategist at BakerAvenue Asset Management.
Wary of a possible “stagflationary” environment of slowing growth and rising inflation, Lip’s firm invests in energy stocks, commodities and precious metals such as gold ETFs or gold mining stocks.
Cresset Capital Management recommends clients underweight equities and increase their exposure to gold, which is considered a safe haven, said Jack Ablin, Cresset’s chief investment officer.
“We’re definitely seeing a pretty aggressive Fed that has really made fighting inflation the number one priority and not necessarily protecting the value of the stock market,” Ablin said.
Certainly, signs of rampant pessimism — such as high cash levels and gloomy sentiment — are often seen as contrarian indicators that are positive for stocks. Hedge funds tracked by BoFA Global Research have recently been piling up in cyclical stocks, which tend to thrive when economic growth is strong.
“Despite waning optimism about global growth, customers do not appear to be positioning themselves for a recession,” BoFA strategists wrote.
Stocks have historically weathered rate hikes quite well. Since 1983, the S&P 500 has risen an average of 5.3% in the six months since the Fed’s first rate hike of a cycle, data from UBS shows.
“The Fed’s goal remains to bring about a soft landing for the economy,” the company’s analysts wrote. “We advise investors to prepare for higher rates while staying involved in the equity markets.”
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