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Specter of Next-Day Losses Haunts Stock Bulls’ Post-Fed Rally

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(Bloomberg) -- Stocks surged for a third straight time after the Federal Reserve delivered a jumbo rate increase. It’s what happened after the last two rallies that’s denting hopes for further gains.

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In May and June, big gains were followed by even bigger selloffs as investors parsed Chair Jerome Powell’s remarks and recalibrated expectations for the likely path of policy moves. Warnings that another downdraft is possible came swiftly from across Wall Street after the S&P 500 surged 2.6% and the Nasdaq 100 delivered its best jump since November 2020.

Bulls glommed onto Powell’s remark that after another potentially big hike in September, it might “likely become appropriate to slow the pace of increases” later in the year so the central bank can assess the effects of its aggressive battle against inflation. Bears countered that’s a far cry from suggesting the Fed is anywhere near ending its tightening cycle, and markets that show rates around 3.5% next year trail the central bank’s latest projections by at least half a percentage point.

“This market move is the victory of hope over experience,” BlackRock’s Jeffrey Rosenberg said on Bloomberg TV. “I’d be a little bit cautious here. The market is hanging on the slowdown in the pace and not really contemplating as much that the more the markets rally here the harder it is for them to continue,” he said.

US stock futures slipped 0.1% as of 6:20 p.m. in New York.

Powell noted that there are signs the economy is slowing, but said the labor market has yet to show any meaningful decline that would warrant the Fed’s pivoting away from its restrictive policies. Inflation worries continue to weigh on consumer sentiment and corporate results show companies struggling to defend margins as input prices surge.

For Sameer Samana of Wells Fargo Investment Institute, Wednesday’s rip higher in risk assets was likely due to thin liquidity and light positioning. The surge also only exacerbated the loosening of financial conditions that’s come as the S&P 500 barrels toward its best month since October. The cross-asset measure of market stresses has eased sharply since June’s super-sized hike, potentially keeping the Fed on a hawkish tilt, and the bounce in stocks looks vulnerable, Samana said.

“Once the positioning is more even, the macro backdrop will remain much the same: sticky inflation, a tightening policy bias, and a weakening economy and consumer,” said Samana, the firm’s senior global market strategist. “The risk/reward from current levels is pretty poor since a further rally in risk and easing of financial conditions will push the Fed toward even larger hikes.”

Historically, big Fed-day rallies have not been sustained, according to Bespoke Investment Group. When the S&P 500 rallies 1% or more on rate decision days, the next day’s average has been a decline of 0.30%, according to Jake Gordon at Bespoke, with gains posted less than half of the time. And performance over the following week and up until the next meeting has also been negative, he wrote in a note, adding that not only is the average performance between meetings the worst when the index rises more than 1% on these days, but is also the only scenario in which stocks have averaged declines.

“Rallies are always fun in the moment, but historically, when the S&P 500 performs well on a Fed day, it has typically been followed by a hangover in between meetings,” Gordon wrote.

Corporate earnings will also have a lot to say about the strength of the economy and where markets go from here. Strong forecasts from Microsoft Corp. and Alphabet Inc. had boosted equities before Powell spoke, but warnings on margins and a second-half slowdown from consumer firms weighed on stocks earlier in the week. Meta Platforms Inc. reported its first-ever quarterly sales decline, citing advertisers’ shrinking budgets. Apple Inc. and Amazon.com Inc. both report late Thursday.

For Peter Tchir, head of macro strategy at Academy Securities, the historic pace of Fed tightening this year is enough to make any equity rallies unstable.

“I want to fade this,” Tchir said. “The economy is worse than the data has indicated so far and this hike will add to problems.”

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