Bruising Stock Reversal Shows How Fed’s Pivot May Come Too Late

(Bloomberg) — For many investors, December has been a shocker in the stock market. After getting sucked in by a rousing seven-week rally, they’ve now had to watch as the S&P 500 posted the longest stretch of down days to begin a month since 2011.

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None of it is particularly surprising to Rich Weiss.

The 62-year-old chief investment officer for multi-asset strategies at American Century Investment Management says a moment of reckoning has been overdue for bulls, whose obsession with Federal Reserve rate policy may have blinded them to economic realities that are likely to end up squashing any rally in equities.

The S&P 500 edged lower Wednesday, extending losses in every session since Nov. 30, when signals from Fed Chair Jerome Powell about a slowing in the pace of interest-rate hikes sparked a 3% rally. Before the latest leg down, the index surged 14% over seven weeks despite a wave of earnings downgrades and weak economic data in areas from housing and manufacturing.

“One of the things which I find dangerous is that many investors right now are myopically, painfully focused on the Fed — and the Fed only — and when that pivot is going to occur,” said Weiss. “And by doing so, they’re not seeing the bigger picture.”

The problem as Weiss sees it is that memories of the swift, Fed-induced pandemic recovery are dominating the thinking of today’s investors, many of whom are so conditioned to the success of dip buying that they’re ignoring a shaky foundation in equities. As much as investors cheer the Fed pivot, the reality is that by the time rates come down the economy is usually too beat-up for stocks to go anywhere.

The S&P 500’s rally since mid-October had been at odds with the bond market, where recession warnings grew louder with long-dated Treasury yields falling further below that of short-term debt. Over the stretch, forecast growth for corporate earnings turned negative in two of the three quarters through June. Back in September, analysts expected profits for all periods to increase roughly 5%, data compiled by Bloomberg Intelligence show.

Weiss’s view may seem off-base in a market where losses have lately been more likely to be spurred by good economic data than bad, befitting the Fed obsession. He’s worried the “pivot” narrative has kept investors from noticing worsening fundamentals with a greater potential to do long-term damage.

“The storm’s coming now,” Weiss said. “Whether it’s going be a tropical rainstorm or a Category 4 hurricane is where people are betting. It’s just a question of how severe and long lasting it’s going to be.”

An update on the consumer price index is due next Tuesday, right before the Fed’s final policy meeting of the year.

To be sure, the S&P 500’s 3.6% drop over five sessions was broader than it was deep, and a retreat of that basic size has occurred almost every month this year. Even after the pullback, the index continues to hover near its 200-day moving average, a threshold that’s widely watched to gauge the market trend. For a 19th straight session, the index sat within 3.1% of the long-term trend line, the longest stretch since 2019.

But the persistent weakness was also rare for a month frequently billed as one of the most favorable for stocks in the calendar year. Over the past two decades, only three other times saw the S&P 500 start a month with a run of losses like this — the latest coming in June 2011. And one has to go back to 1996 to find a December that began on a similarly feeble note.

From Morgan Stanley to JPMorgan Chase & Co., strategists warned that the bear market has yet to run its course, citing the threat of a profit contraction and more restrictive monetary policy from the Fed.

Jason Trennert, chief investment strategist at Strategas Securities LLP, suggested investors betting on a dovish Fed should reconsider their positions. After studying the monetary cycle and stock performance since the 1970s, his team found that a true pivot to accommodative monetary policy often portended pain for equity bulls.

After the first rate cut, the firm’s study shows, the S&P 500 fell in all but one of the previous easing cycles. On average, the index dropped 24% before finding a bottom.

“In many instances, the hopes of a recovery in stock prices lies with the expectation of a Fed ‘pivot’ in monetary policy,” Trennert wrote in a note last month. “History has shown, however, that investors should be careful what they wish for.”

Of course, stocks don’t always track fundamentals closely. But over the long run, they don’t deviate too much from things like earnings. Right now, at about 17 times profits, the S&P 500 trades roughly in line with its 10-year average. That’s a multiple that’s alarming to investors like American Century’s Weiss, considering the 10-year Treasury yield is double its mean level over the same stretch and an earnings recession is looming.

The latest rally was the third time this year that the S&P 500 climbed more than 10% from a trough. The previous attempts, one in March and the other from June to August, both failed to take hold, with the index sinking to fresh lows within weeks.

“There are many investors who are just so fearful they’re going to miss the turn,” said Weiss at American Century. “They keep anticipating the turn and they’re jumping back in, but prematurely.”

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