Wall Street bears get revenge after $7 trillion rally

(Bloomberg) — A sobering warning for Wall Street and beyond: The Federal Reserve is still on a collision course with financial markets.

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Stocks and bonds are set to retreat once again, even though inflation has likely peaked, according to the latest MLIV Pulse survey, as rate hikes reawaken the deep sell-offs of 2022. Ahead of the Jackson Hole symposium later this week, 68% of respondents see the most destabilizing era of price pressures in decades eroding corporate margins and sending stocks lower.

The majority of the more than 900 contributors, which include strategic and day traders, believe that inflation is over. But a whopping 84% say it could take two years or more for the Jerome Powell-led central bank to bring it down to its official long-term target of 2%. Meanwhile, American consumers will cut back on spending and unemployment will rise above 4%.

All of this bearish sentiment underscores the deep skepticism investors harbor about the $7 trillion stock’s unexpected rally of late. While stocks fell last week, the S&P 500 is still limiting its loss for 2022 to 11% from a 23% drop to its mid-June nadir.

“This is a bear market trap,” Victoria Greene, founding partner of G Squared Private Wealth, said in an interview. “Inflation is the big, bad boogeyman. Even if there is indeed a sustained decline in inflation, it could be some time before prices actually come down.”

The survey results spell trouble for bear buyers, who have re-emerged after a horrendous first half – due to bets on a less bullish monetary tightening cycle, while a number of quant funds have shifted to bullish positions. In turn, stocks around the world have clawed back some of their worst losses, while the yield on the 10-year bond has fallen to around 3% from a peak near 3.5% earlier this year.

MLIV respondents, for their part, think bond prices are set to fall again next month, with Fed Chairman Powell having a chance to renew bullish market expectations at this week’s meeting in Jackson Hole Wyoming. Fed funds futures currently show traders betting the central bank will stop hiking after raising the benchmark rate to 3.7% and begin tapering from May 2023. However, even the doves are pushing back, with Minneapolis Fed President Neel Kashkari suggesting a rate of 4.4%. until the end of next year.

It’s hard to overstate why all of this matters. The rapid pace of monetary tightening and the resulting economic impact is the biggest risk for money managers around the world, with interest rates a key driver of corporate valuations. The bad news, according to survey participants, is that inflation will take a significant hit on margins, pushing stocks lower.

While the effect of inflation on margins is very much an open question, the majority of MLIV readers seem closer to the bearish spectrum of a heated debate on Wall Street about where stocks are headed. As high prices persist, consumers are likely to buy less over the next six months, the majority of respondents say.

That’s in line with warnings from the world’s biggest retailer, Walmart Inc., that rising inflation is forcing shoppers to pay more for essential items at the expense of other discretionary items. A cut in consumer spending would impose a clear drag on earnings at S&P 500 companies, which are also struggling with higher wages, rising inventories and ongoing supply chain problems in China.

While S&P 500 margins peaked a year ago, the threshold may be reached in the fourth quarter, according to Bloomberg Intelligence. Consensus estimates for net income margins have fallen about half a percentage point for both the third and fourth quarters since the start of this earnings season, with the communications, health care and consumer sectors among the weakest groups. the BI figures show.

Contributors also estimate that unemployment is likely to rise above 4% but not above 6% — a troubling level that is higher than policymakers expect but lower than in previous severe economic downturns . This offers some comfort that any downturn would be short-lived, providing an opportunity to buy risk assets.

“It’s rare for the Fed to tighten policy aggressively without causing market volatility,” said John Cunnison, chief investment officer at Baker Boyer Bank. “Stocks are not very cheap right now, but they are not as expensive as they were six months ago, especially growth companies.”

For more market analysis, go to MLIV. Sign up for MLIV surveys here.

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