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The current bull market in equities looks sustainable as long as the Federal Reserve doesn’t mess things up.
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Ned Davis Research said Wednesday that a Fed-induced recession is the most likely risk that could derail stocks.
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“If the Fed panics and lowers rates, a bubble peak would be possible,” NDR said.
A Federal Reserve policy error is the biggest risk that could cut short the current bull market in equities, according to a Wednesday note from Ned Davis Research.
The company pointed out that the 25% rally in the S&P 500 from its mid-October low exhibits all the characteristics of a long-term secular bull market rather than a short-term cyclical bull market. But that can change quite quickly if the Fed fails in its interest rate policy.
“Cyclical short bulls tend to occur during secular bear markets and emerging from recessions. Neither describes the current context. Short bulls have also been caused by extraordinary events like a resurgence inflation or a bubble burst. The catalyst for this cycle is more likely to be a Fed-induced recession,” NDR said.
The company said that helping to support the current bull rally is the fact that stocks have been in a secular bull market since 2009, and while it may be closer to the end than the beginning, it is too early to say that a secular bear market has begun. .
“The secular backdrop does not support the brief cyclical bull case,” NDR said.
Additionally, the resilience of the economy since the COVID-19 pandemic means that the 2022 bear market decline in equities occurred in the absence of a recession. This fact promotes the idea that the current equity bull market is more secular in nature than cyclical, according to the note.
As a result, the Fed poses the biggest risk to the stock market, which is the case if the Fed cuts or continues to raise interest rates.
Highlighting an example of how a policy error can occur regardless of the direction of rates, NDR pointed out that the implosion of long-term capital management in 1998 triggered a brief equity bear market and drove the Fed Chairman Alan Greenspan to cut interest rates three times. . Stocks then took off, leading to a bubble.
“The current surge in FANMAG and AI stocks has not been as large as [technology, media, and telecom] stocks in 1999. But if the Fed panics and cuts rates, a bubble peak would be possible,” NDR said.
On the other hand, if inflation persists and Fed Chairman Jerome Powell raises interest rates aggressively again, he could push the economy into a recession and end the bull market.
“A Volcker-type recession in the early 1980s would seem more likely than a Burns/Miller policy error, but an external shock could trigger a resurgence of inflation beyond the Fed’s control,” NDR said.
Ultimately, a lot has to go right for the bull market to be sustainable and long-lasting, and a lot of that depends on whether the Fed finds the sweet spot for interest rates that allow for continued economic growth, but which also keep inflation at bay.
With interest rates hovering over 5%, all eyes will be on the Fed’s next interest rate decision at its July FOMC meeting.
Read the original article on Business Insider