Is the market still too optimistic?(Daily 2-Min S&P 500 Commentary by Sidney Shauy)

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Is the market still too optimistic? A 3rd consecutive 75 bp (0.75%) rate hike by the Fed yesterday was widely anticipated and the market still could not sustain earlier gains and further departed from key level 3,900 we discussed in yesterday’s post. According to the Fed Funds Futures market at CME, the market now expects a 4th 75 bp hike in November followed by a 50 bp hike in December. This would take the Fed rate to end the year at 4.25%-4.50%. Then a last hike of 25 bp in January 2023 to 4.50%-4.75% and finally pause for pretty much the rest of the year. That’s what the market is betting on. So I ask: are they still too optimistic? Because if they are, the stock market will suffer again and again until expectations catch up with reality.

Check out today’s chart in the post’s image. The blue bars represent inflation (CPI) and the green bars to their right represent the Fed rate. In ALL preceding years — 1974, 1981, 1984, 1989, 1995, 2000, 2006, and 2018 — the Fed needed to raise its rate at least ABOVE inflation to kill it. Today, in 2022, for several times the market believed the current Fed hikes were sufficient to kill inflation, only to realize it wasn’t there yet. If this fact holds true, with CPI at 8.3% and Fed rate at 3.25% with the last hike, we still have a very long way to go!

However, there are two ways to shorten this trip. The first is very painful for our society: a recession. More and more likely, a recession can bring inflation down faster. Just look what happened to oil prices. The second is the other often forgotten way of monetary policy: reduce the Fed’s balance sheet. Reducing the record amount of money in circulation in the US economy has the same effect of raising interest rates. Either way, the stock market may be one of its biggest victims.

The Pulse is in the yellow zone. We are holding 1/3 in risk positions for Levels I, II and II+. This means 1/3 at risk and 2/3 in CASH.

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