Bull cases were coming true before Powell warnings destroyed stocks – BNN Bloomberg

Something strange happened to the stock bull’s best arguments as the market slumped in its worst week since June: they turned out to be right.

American companies have enjoyed the biggest profit margins in seven decades. Consumers, always full of money, remain optimistic. Taken together, that might have been too much for Jerome Powell – a man who likely bucks market confidence as he battles inflation. His blunt warning on Friday that the economy will fall victim to the battle sent stocks plummeting.

The S&P 500 plunged more than 3% after the Federal Reserve Chairman said further large hikes may be warranted and rates will stay high until inflation subsides. Lower prices “will likely require an extended period of below-trend growth” and rising unemployment, Powell said at the Kansas City Fed’s annual policy forum in Jackson Hole, Wyoming.

The comments, potentially on purpose, hampered bulls whose arrogance itself had become a concern for policymakers keen to tame a generational price surge. Stocks had surged since June on speculation that the Fed would start cutting rates next year. Those bets faded as investors retreated for an economic downturn that could be more stressful than expected. Treasury yields were little changed, likely capped by investors seeking refuge in government bonds.

“The market was misplacedly optimistic that the Fed would be able to be more dovish today and over the next six to 12 months,” said Phil Orlando, chief equity market strategist at Federated. Hermes. “Powell has dissuaded the market from believing that, and we think stocks should come down, materially lower.”

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The S&P 500 fell 4% in five days for its worst week since the bear market bottomed. Tech stocks lost 5.6% over the period. Virtually all the damage came on Friday, when a listless summer week turned scorching after an eight-minute political talk that saw Powell take direct aim at market optimism.

Stock market gains have been, by Powell’s own admission, a problem for policymakers, who monitor whether measures of stress on assets – known as financial conditions – are “tight enough” to bring down inflation. Stocks had added up to US$7 trillion in value from June lows and 10-year Treasury yields had slipped from multi-year highs as investors grew more confident that any recession would be short and gentle.

“It wouldn’t be a stretch to call this ‘anti-pivot’ talk,” Evercore ISI analysts Krishna Guha and Peter Williams wrote in a note. “Pivotal optimism appears to have lingered longest in equities amid rising hopes for a favorable risk reaction function as trade-offs emerge – setting stocks up for a bigger drop on the day.”

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Though easy to miss amid the flurry of speculation ahead of Powell’s Wyoming turn, these market optimists had gained considerable affirmation for opinions that had already been derided – that profits are not necessarily crushed. by inflation, and that consumer sentiment is not on a one-way trip to the cellar.

In fact, a measure of U.S. profit margins has hit its highest level since 1950, suggesting the prices companies are charging are exceeding their increased costs of production and labor, government data showed this week. Meanwhile, the University of Michigan’s Final Sentiment Index for August rose more than expected as inflation expectations for the year ahead eased.

For those healing wounds on Friday, it may be a minor reward, but these could be trends the bulls are watching closely once the immediate implications of Powell’s speech wear off. After all, from stock pickers to fast traders, nearly everyone has pulled back by trimming equity positions below long-term norms.

Mutual funds have been growing their liquidity at the fastest pace since the global financial crisis, while equity exposure among hedge funds is hovering around a two-year low, according to data compiled by Goldman Sachs Group Inc. .show.

“Liquidity isn’t great and trading desks aren’t full, so it’s hard to read too much into the immediate price action,” said Zachary Hill, head of portfolio management at Horizon Investment. “When the offices are fully staffed after Labor Day, the market setup could be a little different than it is today.”

But Powell has made it clear that corporate profits and happy consumers are not his agency’s priority, and if problems return in those areas, it’s a price he’s apparently willing to accept — a role reversal. for a central bank that for years has been the market’s greatest ally. .

“Powell is telling us that until we see substantial confirmation of slowing price increases, the Fed will keep its foot on the brakes,” said Kara Murphy, chief investment officer at Kestra Holdings. “With the Fed continuing to hike aggressively, earnings are expected to decline further in the second half of the year, which will make the market even more expensive, all else equal.”

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