In July, I warned investors to stay away from large-cap stocks.
“Bearish analysts at Morgan Stanley are probably right that mega-cap tech firms still have room to fall. I’m not anticipating a full turnaround in these companies until 2023.”
Since then, the S&P 500 has lost another 10% of its value.
“Retail has finally blinked,” Managing Director Scott Rubner wrote in a trading desk note. “Capitulation is near. This is the last standing asset owner, who has not sold, [and] is moving money right now.” $89 billion would flow into money market funds in a single week, the most since April 2020.
Unfortunately, stocks still have further to fall. Markets now expect interest rates to rise to 4.6%, and many economists believe it could hit as high as 6% by early 2023.
In that most bearish case, the S&P 500 could drop another 20%-30% before recovering. Much like a homebuyer taking out a mortgage, corporations will find that higher rates make borrowing and raising capital more “expensive,” which lowers the fair value of assets. A permanent 140-basis-point increase in Walmart’s (NYSE:WMT) weighted cost of capital (WACC), for instance, decreases its justified value from $120.40 per share to around $88, a 27% decline. The effect is magnified for early stage companies and other “long-duration” stocks with earnings that need to get discounted further back. (There’s an exception for hypergrowth companies where ultra-high growth rates overwhelm discount rates).
Stock Predictions 2022: When Will Stocks Go Back Up?
Fortunately, the opposite is also true: Rising liquidity is great news for stocks.
It’s why quant-based investors like me tend to focus so intently on the money supply and interest rates. The more liquidity in the system, the greater an economy’s ability to buy everything from stocks to groceries at the supermarket. The 1990 dot-com bubble… the 2009 post-financial-crisis recovery… the 2020 Covid-19 rally… every recent stock market boom has coincided with an improving economy and rising liquidity.
History also provides longer-run evidence. According to data collected by CFRA Research, stocks have risen 12.9% in the years after recessions. Adding data from 1940 increases the outperformance to 16.7%.
|Recession Year||S&P 500 Recession Year Return||S&P 500 Post-Recession Year Return|
In other words, stocks will go back up whenever the Fed indicates that its rate hikes are coming to an end.
The Fed Meeting Every Investor Should Watch
To understand when stocks will go back up, investors should carefully watch the next Federal Open Market Committee (FOMC) meeting on Nov. 1-2, when analysts expect another increase of 50-75 basis points. Billions of dollars will trade hands that day as high-frequency traders digest the news.
Long-term investors, however, should pay closer attention to the tone of Fed Chair Jerome Powell, as well as his top lieutenant, James Bullard.
That’s because the two have become even more skilled than their predecessors at hinting at future rate rises without explicitly giving them away. The 75-basis-point raises in the June, July and September meetings caught few by surprise, despite being some of the fastest rate hikes in U.S. history.
“Traders had fully priced in the 0.75 percentage point move and even had assigned an 18% chance of a full percentage point hike,” analysts at CNBC noted. “Futures contracts just before Wednesday’s meeting implied a 4.545% funds rate by April 2023.”
A more aggressive tone from them should therefore be met with deep caution. A rise beyond the 4.5%-5% interest rate range will send stocks further down by year-end; the S&P 500 could end the year under 3,000 in this case. But because markets are already pricing in a 4.5% rate, according to my models, a less aggressive stance will signal the near-bottom of the market.
Economic data favors the first option, in which rates rise beyond 4.5% and stocks struggle through November. Labor markets remain too strong to tamp down core inflation.
But over the longer run, investors should expect markets to begin recovering by year’s end, or at least by early 2023. The Fed has proved that it’s willing to send America through a short-term recession to get inflation under control. And even if Mr. Powell and Mr. Bullard maintain a hawkish tone next month, cash-hoarding investors can still wait until December to come back out of hiding.
On the date of publication, Tom Yeung did not hold (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.