NEW YORK (Reuters) — Wall Street stormed this week after absorbing a long-awaited rate hike from the Federal Reserve, leaving investors to consider whether stocks are poised for a sustained rebound or more turbulence.
After a months-long beating, the S&P 500 posted its best weekly gain since November 2020 as investors applauded greater clarity on monetary policy and an encouraging assessment of the U.S. economy from the Fed. The surge has nearly halved the index’s year-to-date losses, although it is still down 6.7% for 2022 after suffering a correction last month.
Whether to embark on the rally is a thorny question in a market that still faces its share of risks, including the hawkish rate hike path the Fed unveiled on Wednesday and geopolitical uncertainty surrounding the invasion of Ukraine by Russia.
Still, some big banks think the worst may be over, for now. Strategists at UBS Global Wealth Management said on Friday that the expected pace of Fed tightening is “consistent with rising equities” and advised clients to stay invested in equities.
Earlier in the week, JPMorgan forecast the S&P 500 to end the year at 4,900, about 10% above Friday’s close, saying markets “have now erased the long-awaited Fed liftoff with a politics probably as warmongering as possible”.
Others are less optimistic. Fears that the Fed’s fight against inflation could hurt growth were apparent in the bond market, where yield curve flattening accelerated after the Fed’s monetary policy meeting this week. An inverted yield curve, in which yields on short-term government bonds exceed those on longer-term bonds, has been a reliable predictor of past recessions.
Stubborn inflation, sky-high commodity prices and few signs of an end to the war in Ukraine further cloud the picture for investors, said Rick Meckler, partner at Cherry Lane Investments.
“The markets are more complicated now by interest rates, they are more complicated by inflation, and they are certainly more complicated by the Russian situation,” he said. “You’ve had a lot of people this week thinking we’ve bottomed out, but it’s hard to keep having higher and higher prices just on that basis.”
Many also believe that the week’s sharp rises in equities should not ease the economic worries that have fueled bearish sentiment in recent months.
Fund managers’ allocation to cash 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 Retail Investors showed, well above the historical average of 30.5%.
“The thing we’re most concerned about right now…is really whether we’re going into a recession or not,” said King Lip, chief strategist at BakerAvenue Asset Management.
Wary of a potential “stagflationary” environment of slowing growth and rising inflation, Lip’s company invests in energy stocks, commodities and precious metals such as ETFs on gold or stocks gold mines.
Cresset Capital Management recommends clients underweight equities and increase their exposure to gold, which is considered a safe-haven asset, said Jack Ablin, chief investment officer of Cresset.
“We certainly see a fairly aggressive Fed that has really made fighting inflation its number one priority and not necessarily protecting stock values,” Ablin said.
To be sure, signs of creeping pessimism — such as elevated cash levels and austere sentiment — are often seen as positive contrarian indicators for stocks. Indeed, hedge funds tracked by BoFA Global Research have recently piled on cyclical stocks, which tend to thrive when economic growth is strong.
“Despite waning global growth optimism, clients do not appear to be positioning themselves for a recession,” BoFA strategists wrote.
Historically, equities have weathered cycles of rising rates quite well. Since 1983, the S&P 500 has returned an average of 5.3% in the six months following the Fed’s first rate hike in a cycle, according to UBS data.
“The Fed’s objective remains to engineer a soft landing for the economy,” the firm’s analysts wrote. “We advise investors to prepare for higher rates while remaining committed to equity markets.”