The Ruin of Politics

The Credit Strategist June 2022

As discussed in my recent blog (“Market Price Targets,” May 21, 2022), I do not think this bear market has seen its lows.  As a base case, I expect the S&P 500 to drop to the 3400 range representing ~14x forward earnings of $235 assuming the Fed initiates two more 50 basis point interest rates hikes before July 4th and one more 50 basis point hike by Labor Day.   The Fed is starting QT today (ramping up to $95 billion monthly by August) which will pressure markets as well (particularly credit markets). This will lift the Federal Funds rate to 2.25-2.50% in September, significantly higher than January but still well below the rate of inflation.  At that point, the Fed will probably wait and see how QT goes and hope it doesn’t have to hike rates any further.  It would be surprising if inflation dropped anywhere close to the Fed’s 2% target by then absent a sharp slowdown in economic activity, but we can always hope that happens. The Fed will then have to decide if it wants to brave the political resistance it will unleash by raising rates any further.

Another 100-150 basis points of interest rate increases could easily push the S&P 500 down to the 3400 level absent signs of inflation relief.   The question is whether higher rates will push the S&P 500 and other major indices even lower, a non-trivial possibility (the Nasdaq remains the most vulnerable with its high number of unprofitable infinite duration stocks).  If inflation remains sticky and the market senses the Fed needs to do more, 3000 and below may come into play.  With the latest bear market rally pushing the S&P 500 back to 4158 as of the close of trading on May 27th (and well above bear market territory), a drop back to 3400 is going to be very painful and a deeper drop to 3000 or lower could cause the jokers on CNBC to break out black arm bands.  The S&P 500’s recent closing low of ~3900 on May 19th was relatively orderly and didn’t feel like the type of washout we probably need to reach a true bottom.  The Nasdaq has taken far more damage but its many unprofitable stocks still sport absurdly rich valuations that need to be purged before the market reaches bottom.  The bear is sly; she is making every effort to draw in more victims through sharp market rallies that tempt investors into thinking the worst is behind them.  Do not be fooled.  The Fed is at best only halfway through tightening (and if only halfway is probably on the way to another epic policy failure). Until we see palpable evidence of a significant decline in inflation, nobody should count on our feckless central bankers to bail them out.