- The stock market won't find its bottom until the Federal Reserve pauses its current tightening cycle, the consensus on Wall Street seems to be.
- For the Fed to pause hiking interest rates, it needs to see lower gas prices, inflation, and GDP growth, according to Stifel.
- Stocks will bottom "when the Federal Reserve signals that it feels inflation pressures have started to ease," DataTrek said.
The ongoing decline in the stock market is likely to last for as long as the Federal Reserve continues its current tightening cycle, according to notes from Stifel and DataTrek Research.
The Fed began unwinding its pandemic-related stimulus in March, when it hiked rates for the first time since 2018. It continued the process by raising them another 50 basis points earlier this month, and signaled that it plans to begin reducing its $9 trillion balance sheet starting next week.
The ongoing tightening cycle, which is expected to include at least two more 50-basis-point rate hikes over this summer, is likely the biggest headwind for stocks as they try to rally from their current bear market depths. The Nasdaq 100 is down about 30% year-to-date, while the S&P 500 is down nearly 20% over the same time period.
But for the Fed to slow down or pause its quantitative tightening cycle, it would need to see three main criteria, according to Stifel: lower gas prices, lower inflation, and lower GDP growth. In other words, bad news may be good news for investors and the stock market. Stifel expects some of those factors to materialize in the fourth quarter of this year, which could set stocks up for a rally into year-end.
There are inklings that the stock market sell-off and swift interest rate hikes are already taking a toll on the economy. New home sales fell 17% in April as mortgage rates spiked above 5%, layoffs are starting to pick up, and the so-called wealth effect could lead to reduced spending as consumers check on the balance of their retirement accounts.
What separates the current market decline from others is that the Fed likely welcomes the ongoing stock sell-off as a tool to fight inflation, according to DataTrek.
"Lower stock prices tell companies to stop hiring so aggressively and feeding wage inflation. They also create a reverse wealth effect, which should curtail consumer spending. The Fed also knows that the S&P 500 is still 15% above its February 2020 pre-pandemic peak of 3,386. Long term holders of US equities still have reasonable gains," DataTrek co-founder Nicholas Colas said.
But for now, as long as the Fed sticks with its tightening cycle, the playbook for investors is to own more value stocks relative to growth, according to Stifel.
"Until the Fed is less hawkish and oil breaks down, we'll stay with our 10:3 ratio of defensive value and selected growth," Stifel's Barry Bannister said.