The S&P 500: Don't Fight The Fed

Summary

  • A wise man told me once - "don't fight the Fed." Just as the market can rise, it can fall.
  • While it may be difficult to fathom, rates are going even higher from here.
  • The economy will feel more pain, and corporate profits should get impacted.
  • The upcoming earnings season is an increasing concern. We could see worse than expected results and significant weakness in guidance.
  • Valuations should continue getting adjusted lower, and the base case bottom may be about 20% below here.
  • This idea was discussed in more depth with members of my private investing community, The Financial Prophet. Learn More »
Economic crisis that will affect the world grow of inflation and fuel price

Leonid Sorokin

A wise man told me - "you don't fight the Fed." As the Federal Reserve expanded its balance sheet, reduced interest rates, and implemented other easing measures, the central bank decreased borrowing costs, stimulated growth, and flooded markets with ultra-cheap capital. If you were short stocks or didn't go long the market during this post-2008 ultra-easy monetary environment, you fought the Fed and probably missed out on years of stellar gains. However, we want to remember that the market goes both ways, and just as you don't want to fight the Fed when it's easing, you also don't want a fight with the Fed when it's tightening interest rates. Many market participants recently learned this lesson the hard way, but the class is not over yet.

While the S&P 500/SPX (SP500) has dropped by 25% from its top, more downside is probable as the Fed continues tightening. Fundamental, technical, and psychological factors are converging, which support lower stock prices into the fall and winter months. My S&P 500 base-case bear-market-bottom target-range remains at 3,200-3,000. However, the market could overshoot and drop into a lower range (2,800-2,400).

The Technical Image - There Is A Chance

SPX

SPX (StockCharts.com)

There's a relatively low probability that the SPX will put in a sustainable double bottom around the 3,650 level. However, while there's a chance, the likelihood of a long-term bottom here is very low. We could see a short-term rebound to about the 3,800-4,000 resistance zone, but selling pressure should resume after that. While the market is modestly oversold here, we still have not seen any of the hallmark signs of a true long-term bottom. It will probably require panic-like, capitulation-style selling before a bear market low forms.

Higher Interest Rates Are Approaching

As anticipated, the Fed raised the benchmark rate to 3-3.25%. This rate increase elevates rates to a relatively high level, which could exacerbate the economic slowdown in the coming months. Increased pressure on the consumer due to rising borrowing costs and inflation should lead to worsening consumer confidence and spending. Also, as rates rise, corporations should face higher expenses due to inflation and increased borrowing costs. Moreover, the Fed is not done yet. There's a high probability that we will see another 75 basis point increase at the November FOMC meeting. We should see the benchmark at about 4% going into year-end.

Fed Watch

Fed Watch (CMEGroup.com)

It may not be easy to fathom, but rates are heading even higher from here. The benchmark will probably increase to around 4% at the November meeting. Moreover, the Fed may keep the benchmark at about 4-5% throughout 2023. Elevated rates should continue driving up borrowing costs, constricting the economy as we advance in the coming months. The economy is not accustomed to such high-interest rates, and we should see the slowdown worsen as we move into the fall and winter months.

Upcoming Earnings - A Big Concern

A primary concern is the upcoming earnings season. Q3 earnings will kick off around mid October, and while we've seen some downward revisions, we may see steeper revenues and EPS declines than we'd hoped. Inflation and higher borrowing costs lead to margin compression and lower profitability, while worsening consumer spending could lead to revenue declines. Additionally, companies will likely need to adjust forward guidance due to higher rates, persistent inflation, and the increased slowdown effect. Therefore, we could see a higher percentage of misses, leading to more stock price drops. Furthermore, the uncertainty regarding the November interest rate increase should fuel volatility throughout the earnings season.

Valuations - Should Get Adjusted Lower

Shiller P/E Ratio

Shiller P/E ratio

Shiller P/E ratio (mltpl.com)

Despite a recent drop from the highs, the CAPE P/E ratio remains relatively high, illustrating that valuations still likely have room to adjust lower. The S&P 500's historical mean CAPE ratio is only around 17, roughly 37% below current levels. We should consider that earnings and earnings expectations could worsen considerably in the coming months, leading to widespread EPS and revenue estimate adjustments. Therefore, we could see the SPX's Shiller P/E ratio fall to around the 22-20 range, implying a possible drop to about the 3,200-3,000 support level. However, in a bearish case scenario, if the market overshoots to the downside, the Shiller P/E ratio could revert to its mean of about 17, implying a crash to about 2,500 is possible.

Are You Getting The Returns You Want? 

  • Invest alongside the Financial Prophet's All-Weather Portfolio (2021 return 51%), and achieve optimal results in any market.
  • Our Daily Prophet Report provides the crucial information you need before the opening bell rings each morning.
  • Implement our Covered Call Dividend Plan and earn an extra 40-60% on some of your investments.

All-Weather Portfolio vs. The S&P 500
Don't Wait, Unlock Your Own Financial Prophet! 

Take advantage of the 2-week free trial and receive this limited-time 20% discount with your subscription. Sign up now, and start beating the market for less than $1 a day! 

This article was written by

Victor Dergunov profile picture
37.69K Followers
The #1 Service For Diversified Portfolio Profits

Hi, I'm Victor! It all goes back to looking at stock quotes in the old Wall St. Journal when I was a kid. What do these numbers mean, I thought? Fortunately, my uncle was a successful commodities trader on the NYMEX, and I got him to teach me how to invest. I bought my first actual stock in a company when I was 20, and the rest, as they say, is history. Over the years, some of my top investments include Apple, Tesla, Amazon, Netflix, Facebook, Google, Microsoft, Nike, JPMorgan, Bitcoin, and others.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long a diversified portfolio with hedges.

Recommended For You

Comments (15)

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.