Till yesterday- sentiment across the market was too negative. Clearly economy is slowing down but until yesterday there was no sign of Fed to stop raising rates. Although S&P has just declined 10% from the recent high in July - it was the overall effect that was being felt across the market.
To just give a background IWM was where it was 5 years ago. That is small caps. 5 years of no return. 30% of the companies in IWM are still facing fear of bankruptcy. Technically it was in the verge of breaking down. Although S&P was not declined to that level but it is also at the same level 2 years ago. If you dollar cost average in S&P like I have since March 2021 - you have negative returns. Only handful of companies had positive overall returns while rest of the market struggles.
I used to know a friend - whose father committed suicide in India when stock market crashed. I never understood that at that age but I could see or feel that fear - yesterday. It is not the market crash that kills people - it is the lack of hope that kills them. When you are 60 odd and you have all your life earnings put in the market and it crashes 50-60% - you can somehow gather the courage that market will bounce back - it usually do - it almost always do - but it when you lose that hope - that’s what kills people - usually old people - because they don’t have the years left for to remain hopeful. Japanese market has not seen the all time high since last 45 years. Imagine waiting for that. Situation was that bleak.
My own 401k returns were negative since last 4 and half years till yesterday. So - today - although Powell did not declared a victory - but his speech and stance installed the much needed hope.
The most important statement from todays speech was - that Fed feels there is equal amount of risk in raising or not raising rates. This means Fed does see signs of slowing economy and panic in the market. Fed also understands one more rate hike could break the market and economy. This is second consecutive pause and there is high probability that Fed is done raising rate now.
This will install fear in the bond buyers the most. They may not see 5% Yield in longer term bonds. That means we may see first rally in bonds starting tomorrow. Particularly longer to medium dated bonds. 7 year- 10 year yield should decline as there will be demand for bonds. Yield decline temporarily also help stocks. Particularly mega cap stocks - but that rally will fade soon as rates are still very high and Economy is slowing.
However - bonds will continue to rally and any signs of them going near to 5% yield - they will be bought. For stocks - it will stock pickers market for next 6 months - There are companies which is generating good cash flow and has better balance sheet - with low debts - will see buyers but there are others who has lot of debts will continue to struggle and sell off. We are still in higher for longer market and Fed is not thinking about thinking about thinking about cutting rates.
However if inflation and job data support for next 2 to 3 months - particularly in Feb 2024 when we get Jan inflation print and that shows Year over Year growth of below 3% - Fed will start saying rate cut is coming - probably in June 2024.
However next 6 months are critical for soft landing. Unemployment shouldn’t rise above 5% - Mortgage rate need to decline to at least 6% from 8 - and inflation print needs to show below 3% for 2 or 3 months in 2024. Should all that happen we can consider we are out of this mess and pain ride.
