The Stock Market Bet Wrong on Fed Rate Cuts
Michael Kramer | Sep 21, 2023 15:24
Stocks finished lower yesterday, following more hawkish-than-expected projections from the Fed for 2024 and 2025. The Fed anticipates rates to be at 5.1% by the end of 2024, signaling just 50 basis points of rate cuts next year.
This is a significant departure from market expectations in mid-May. At that time, the December 2024 Fed Funds Rates were trading at 2.86%.
Those same Fed Funds Rates are trading at 4.8% and are likely to continue rising towards the Fed’s target of 5.1% over time, which is more than a 200 bps difference.
This is crucial to note: as real rates began to rise in mid-May, the Nasdaq earnings yield declined, causing the two measures to converge. The equity market had been betting on many rate cuts in 2024 and a corresponding decline in real yields.
This turned out to be a misguided bet. For months, the Fed has been signaling that its policy would be “higher for longer.”
It indicated that rate cuts were not on the horizon anytime soon. If there were to be any rate cuts, they would merely be adjustments for lower inflation, while real rates would remain restrictive.
On May 11, the spread between the Nasdaq’s earnings yield and the 10-year Real yield was 2.7%; now, that spread has narrowed to just 1.7%, a difference of 100 basis points.
While this may not sound significant, consider that the earnings yield of the Nasdaq would need to increase to 4.7% from its current 3.7% to return to that May 11 spread.
This would require the Nasdaq’s P/E ratio to fall from its current 27.0 to 21.3, representing a drop of 21.1%. Such a decrease would bring the index back to its lows from March 13.
Get The App
The equity market appears to have made an incorrect bet on the direction of interest rates. If rates continue to rise, it’s logical to expect that the earnings yield of the Nasdaq will need to increase correspondingly, leading to a lower valuation multiple.
Additionally, Powell stated twice yesterday that the neutral interest rate could be higher than initially anticipated, suggesting that rates may need to rise more than once in the future.
His comments during the press conference made it clear that there is no fixed rate plan; I would interpret that as the Fed will react to each new piece of data as it comes in and ultimately has no clue what comes next.
h2 S&P 500: More Downside in the Offing?/h2From a technical analysis standpoint, it appears that the diamond pattern on the S&P 500 has broken. If this is the case, we could see the index reach 4,330 rather quickly.
Should the 4,330 level break, it would also likely signify that the neckline of the head and shoulders pattern has been breached, pointing to further downside potential.
Meanwhile, the 10-year real yield saw a notable breakout today, clearing both resistance levels and ending a month-long period of consolidation.
Meanwhile, the 2-year rate also experienced a breakout, clearing a nearly six-month-long period of consolidation at 5.1%. It appears poised to run up to 5.25%, which is now only eight basis points away, after closing at 5.17%.
The VanEck Semiconductor ETF (NASDAQ:SMH), focused on semiconductors, is currently sitting at a critical support level of $143.50. There are significant unfilled gaps down to $129. The $143.50 level is an important threshold; a break below it would signal a bearish turn for the ETF.
Meanwhile, Advanced Micro Devices (NASDAQ:AMD) looks weak and sits on support at $100. A break of support probably leads to a decline to around $93 and maybe as low as $81.
/h2
Meanwhile, Alphabet (Nasdaq:GOOGL) appears to have a rising wedge pattern that has formed and a giant gap that was never filled at $122, as well as another one at $111 and a downward-sloping RSI.
Original Post
Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.