Shares of the SPDR S&P 500 ETF Trust (NYSE:SPY) have continued to remain volatile. SPY stock has been careening wildly day to day but still remains within a well-defined range on a week-to-week basis. Interest rates, valuations and technicals all point to this “big range, no change” type of price action to continue over the coming weeks.
It is no mystery that the Federal Reserve intends to raise interest rates over the rest of 2022. Currently, expectations are for seven more rate hikes this year. This equates to one at every future Federal Reserve meeting in 2022.
This would put the terminal Fed Funds target rate to end the year around 2%.
Rising rates have a dual negative effect of crimping corporate profit margins and compressing valuation multiples. It is important to remember, however, that interest rates will still be historically low, even after this series of hikes.
Many market observers think the Fed will overshoot and be forced to lower rates sometime in 2023. This was a big reason we saw stocks rally sharply after last week’s Fed meeting.
Look for this grinding back and forth to continue, especially now that 10-year yields are back above the 2% level in a big way. The last time we saw yields this high on the back end of the curve was May 2019.
Higher rates will ultimately hurt high-growth tech names but be a big benefit for the big banks and value stocks. This rotation out of growth into value will likely keep stock prices stagnant over the next several quarters.
Valuations
Some have been arguing that stocks are still cheap compared to interest rates. This is the T.I.N.A. (There Is No Alternative) argument. That argument, though, has fallen by the wayside now that the yield on the 10-year bond has catapulted to over 2.3%.
The price-earnings ratio for the SPY was at 20.50 in May 2019 when the 10-year yield was last at a similar level near 2.3%. Now the P/E ratio stands near 25. Not egregiously expensive but certainly not cheap.
It will be difficult for a further multiple expansion to push stocks higher now that interest rates are on the rise. Almost two-thirds of the rally over the past several years was attributable to an ever-expanding Fed balance sheet and uber-easy monetary policy, not to earnings growth.
Now that the Fed has turned hawkish, companies need to step up. Earnings will have to be the driver of returns going forward. And I think it will take several quarters for earnings to catch up to the still-somewhat-rich valuations.
Technical Take on SPY Stock
The SPY has been rangebound for the better half of the past year.
There was a brief upside breakout to end 2021 that was ultimately met with some serious selling. Major upside resistance resides around the $460 area. February saw two failed attempts by SPY stock to push past resistance. The subsequent sell-off took shares all the way down to the $420 support level before buyers stepped in on three seperate occasions.
Source: The thinkorswim® platform from TD Ameritrade
Currently, SPY stock sits in the middle of the trading range at around $449. The widely followed 20-day moving average is at $431. I expect consolidation and sideways price action to continue over the coming months.
How to Trade It Now
It is likely to be a stock-pickers market for the rest of 2022. The tide that lifted all boats — easy Fed policy — has gone out to sea. Stock traders should use rallies to trim out of long positions and pullbacks to put their positions back on. Stay nimble, be patient and wait for opportunities.
Option traders can exploit the anticipated trading range environment by selling out-of-the-money call spreads with short strike prices near overhead resistance areas and similar out-of-the-money put spreads with short strikes near major support levels. This iron condor trade also benefits from still-elevated option implied volatility.
On the date of publication, Tim Biggam did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
