(Bloomberg) — A sober 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 fall once again, though inflation is likely to have peaked, according to the latest MLIV Pulse survey, as rate hikes spark the big sell-off of 2022. Ahead of the Jackson Hole symposium later this month This week, 68% of respondents see the most destabilizing era of price pressures in decades, eroding corporate margins and depressing equities.
Most of the 900+ contributors, which include strategists and day traders, estimate that inflation has peaked. Still, a staggering 84% say it could take two years or more for the central bank led by Jerome Powell to reduce it to the official long-term target of 2%. Meanwhile, US consumers will cut spending and unemployment will rise by more than 4%.
All these bearish sentiments underscore the deep skepticism of investors in the face of an unexpected $7 trillion rally in stocks of late. While stocks tumbled last week, the S&P 500 still reduced its 2022 loss to 11%, down from a 23% decline in mid-June.
“This is a bear market trap,” Victoria Greene, founding partner of G Squared Private Wealth, said in an interview. “Inflation is the big bad boogie man. Even if there is really a sustained drop in inflation, it may take a while before prices actually drop significantly.”
The survey results spell trouble for bearish buyers, who have re-emerged after the horrendous first half – driven by bets on a less aggressive monetary tightening cycle, while a number of quantitative funds shifted to a bullish stance. In turn, equities around the world have recouped some of the worst losses, while the 10-year Treasury yield has fallen to around 3% from its peak near 3.5% earlier this year.
MLIV respondents, meanwhile, estimate bond prices are likely to fall again next month, with Fed Chair Powell having the opportunity to refresh market expectations at this week’s meeting in Jackson Hole, Wyoming. Fed fund futures currently show that traders are betting that the central bank will stop rallying after raising the benchmark to 3.7% and will start cutting as early as May 2023. However, even the doves are pulling back, with Minneapolis Fed Chairman Neel Kashkari recommending a rate of 4.4%. until the end of next year.
It’s hard to overstate why all of this matters. An accelerating pace of monetary tightening and the resulting economic fallout are the biggest risk for money managers around the world, with interest rates being a major driver of corporate valuations. The bad news, according to survey participants, is that inflation will take a significant hit to margins, pushing equities lower.
While the effect of inflation on profit margins is an open question, most MLIV readers appear to be closer to the downside of a heated Wall Street debate over where stocks are headed. As high prices persist, consumers are likely to buy less over the next six months, according to most respondents.
This is in line with warnings from the world’s biggest retailer, Walmart Inc., that rising inflation is forcing shoppers to pay more for essentials at the expense of other discretionary items. A cut in consumer spending would put a clear brake on profits for 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 decline may not come until the fourth quarter, according to Bloomberg Intelligence. Consensus estimates for net profit margins have dropped about half a percentage point for the third and fourth quarters since this earnings season began, with communications services, healthcare and consumer sectors among the weakest groups, BI data shows. .
Pulse taxpayers also estimate unemployment to rise above 4% but not higher than 6% – a worrying level that is higher than what policymakers are anticipating, but lower than in previous severe economic downturns. This offers some comfort that any recession would be short-lived, providing a dip-buying opportunity for risky assets.
“It’s rare for the Fed to aggressively tighten policy without causing market volatility,” said John Cunnison, chief investment officer at Baker Boyer Bank. “Stocks are not very cheap now, but they are not as expensive as they were six months ago, especially growth companies.”
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