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Stocks Historically Don’t Bottom Out Until the Fed Eases

The New York Stock Exchange. Tighter monetary policy, along with high inflation, has many investors fearing an economic downturn.
Photo: yuki iwamura/Agence France-Presse/Getty Images

Another week of whipsaw stock trading has many investors wondering how much farther markets will fall.

If history is any guide, the selloff might still be in its early stages. 

Investors have often blamed the Federal Reserve for market routs. It turns out the Fed has often had a hand in market turnarounds, too. Going back to 1950, the S&P…

Another week of whipsaw stock trading has many investors wondering how much farther markets will fall.

If history is any guide, the selloff might still be in its early stages. 

Investors have often blamed the Federal Reserve for market routs. It turns out the Fed has often had a hand in market turnarounds, too. Going back to 1950, the S&P 500 has sold off at least 15% on 17 occasions, according to research from

Vickie Chang,
a global markets strategist at Goldman Sachs Group Inc. On 11 of those 17 occasions, the stock market managed to bottom out only around the time the Fed shifted toward loosening monetary policy again. 

Getting to that point may be painful. The S&P 500 has fallen 23% in 2022, marking its worst start to a year since 1932. The index declined 5.8% last week, its biggest decline since the pandemic-fueled selloff of March 2020.

And the Fed has only just gotten started. After approving its largest interest-rate increase since 1994 on Wednesday, the central bank signaled that it intends to raise rates several more times this year so it can tamp down inflation. 

Tightening monetary policy, combined with inflation running at a four-decade high, has many investors fearful that the economy might go into a downturn. Data on retail sales, consumer sentiment, home construction and factory activity have all shown significant weakening in recent weeks. And while corporate earnings are strong now, analysts expect they will come under pressure in the second half of the year. A total of 417 S&P 500 companies mentioned inflation on their earnings calls for the first quarter, the highest number going back to 2010, according to FactSet. 

Fed Chairman Jerome Powell on a NYSE screen Wednesday, when the central bank signaled that it intends to raise rates several more times this year.
Photo: BRENDAN MCDERMID/REUTERS

In the coming week, investors will be parsing data including existing-home sales, consumer sentiment and new-home sales to gauge the economy’s trajectory. U.S. markets are closed Monday in observance of Juneteenth.

“I don’t think the rate of the decline in the market will continue at this pace, but the idea that we’re approaching the bottom—that’s really hard to come up with,” said

David Donabedian,
chief investment officer of CIBC Private Wealth US. 

Mr. Donabedian said he has discouraged clients from trying to “buy the dip,” or to buy shares on discount with the expectation that the market will turn around soon. Even after a punishing selloff, stocks still don’t look cheap, he said. And earnings forecasts still look too optimistic about the future, he added.

The S&P 500 is trading at 15.4 times its next 12 months of expected earnings, according to FactSet, just a hair below its 15-year average of 15.7. Analysts currently still expect S&P 500 companies to report double-digit percentage earnings growth in the third and fourth quarters, according to FactSet.

The Dow and the S&P 500 index had their worst 100 days to start a year in more than 50 years. And the Nasdaq had its worst start to a year in the history of the index. But if history is a guide, the selling may have only just begun. WSJ’s Dion Rabouin explains. Photo Credit: Spencer Platt/Getty Images

Other investors say they are staying wary of the possibility that the Fed might have to act even more aggressively, should policy makers be surprised by another unexpectedly high inflation reading. The University of Michigan’s consumer-sentiment survey, released earlier in the month, showed that households expect inflation to run at a 3.3% pace five years from now, up from 3% in May. That marked the first increase since January. Separately, the Labor Department’s consumer-price index rose 8.6% in May from the same month a year ago, the fastest increase since 1981.

“Our feeling is that if the next inflation figure is very high again, the Fed could [raise rates] even more sharply,” said

Charles-Henry Monchau,
chief investment officer at Syz Bank, in emailed comments. That could put further pressure on risky assets such as stocks, he added.

When the Fed began raising interest rates again this year, it said it was hoping to pull off a soft landing, a scenario in which it slows the economy enough to rein in inflation but not so much that it triggers a recession. 

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Within recent weeks, many investors and analysts have become increasingly pessimistic that the Fed will be able to pull that off. Data have already shown signs of economic activity cooling. As rate increases further raise the cost of borrowing for consumers and businesses, it is difficult to envision a way in which the Fed is able to avoid a downturn, many analysts say. 

The Fed’s moves “raise the risk of a recession starting this year or early next year and raises the risk frankly that they’re not going to be able to keep raising rates that long,”

David Kelly,
chief global strategist at J.P. Morgan Asset Management, said on a conference call with reporters Wednesday.

“I wouldn’t be surprised if within a year, we’re having a meeting where the Fed is considering cutting rates,” he added.

Unsurprisingly, stocks typically don’t do well during recessions. The S&P 500 has fallen a median of 24% during recessions going back to 1946, according to research from Deutsche Bank.

“If we don’t get a recession, we are getting close to extreme territory,” Deutsche Bank strategist

Jim Reid
wrote in a note.

The silver lining for investors is that, when the Fed begins to shift toward easing monetary policy, markets have historically responded positively and quickly—especially if the primary cause of their slide was related to central-bank policy, according to Goldman Sachs’s analysis.

What no one is sure of is when exactly the Fed will shift gears, and how much more pressure the economy might come under in the meantime.

“I expect the summer to be very choppy,” said

Nancy Tengler,
chief investment officer at Laffer Tengler Investments.

Write to Akane Otani at akane.otani@wsj.com

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