Are investors ignoring the Federal Reserve's warning?

2023-06-25 19:24

Stocks fell last week as several signs pointed to the Federal Reserve continuing to hike rates this year.

The S&P 500 fell 1.4% for the week, the Dow Jones Industrial Average slipped 1.7% and the Nasdaq Composite declined 1.4%. All three major indexes snapped weeks-long streaks of gains that had pushed the S&P 500 into bull market territory and sent mega-cap tech stocks to all-time highs.

What drove last week's losses? Federal Reserve Chair Jerome Powell testified before congressional leaders on Wednesday and Thursday that the central bank remains committed to bringing inflation down to 2%, and signaled that it will likely raise rates two more times this year.

However, investors don't seem to believe that two more hikes are coming: Futures traders are currently pricing in just one more rate hike this year.

The Bank of England also raised interest rates by half a percentage point, surprising investors who expected a quarter percentage point hike.

Wall Street doesn't appear skittish, despite the Fed's hawkish signaling, the BoE hike and last week's losses. The Cboe Volatility Index, known as the VIX, is derived from S&P 500 index options prices and measures volatility expectations. Wall Street's fear gauge fell to 13.44 last week.

Mega-cap tech stocks also saw notable gains, even against the backdrop of a broader market sell-off. Apple shares rose to an all-time high close of $187 on Thursday.

Are investors ignoring the Fed? Not necessarily. Investors simply have a different outlook on inflation than the Fed, says Tom Graff, head of investments at Facet Wealth, an investment advisory firm. In other words, while investors believe that the Fed could indeed raise rates two more times if inflation remains high, they believe that inflation will actually continue to cool.

Recent inflation readings support that expectation: The May Consumer Price Index showed that consumer prices last month rose at the slowest annual pace since March 2021. Meanwhile, the May Producer Price Index showed that inflation at the wholesale level cooled to below its pre-pandemic average.

"There isn't this fear there that gripped us all through 2022 that, oh, the Fed might hike us to oblivion," said Graff.

The Fed could also be signaling more rate hikes to give itself flexibility while minimizing potential market volatility. Signaling more rate hikes are coming and then not making those hikes would be less of a big deal to investors than forecasting cuts or a pause and hiking instead, he says.

Was last week's sell-off a blip or the start of a trend? That's the million dollar question. But no matter which way stocks are headed, that path likely won't be linear.

There are some signs that the market could be headed higher. The rally, led narrowly by mega-cap tech stocks like Nvidia and Microsoft this year, has broadened in recent weeks to include other asset classes including beaten-down small-cap stocks.

The share of stocks in the S&P 500 trading above their 200-day moving averages, a popular technical indicator for market breadth, has also increased in recent weeks.

But while more than 60% of stocks in the S&P 500 are trading above that trend-line, "it's not quite enough to be convincing of a new bull market, when 80-90% of constituents are typically trading above their 200d MA for most of the first year off a major bottom," wrote Liz Young, head of investment strategy at SoFi.

The next test for stocks will likely be the upcoming earnings season, especially considering that earnings results that have come in better than feared so far this year have helped fuel the market rally, says Gina Bolvin, president of Bolvin Wealth Management Group.

"Getting back to fundamentals can push this market higher and should push this market higher," she said.

Bitcoin price notches new high for 2023

Bitcoin last Friday rose to its highest level in about a year, climbing to above $31,400 a coin before paring back its gains.

The world's largest cryptocurrency by market capitalization had earlier this week traded above $30,000 for the first time since April, after the collapses of Silicon Valley Bank and Signature Bank sent investors fleeing to crypto as an alternative place to hold cash.

Bitcoin's surge comes on the heels of several financial firms seemingly venturing into the crypto market. BlackRock last week applied to register a bitcoin spot exchange-traded fund. EDX Markets also launched its digital asset trading platform this week. The crypto exchange fund is backed by financial companies such as Charles Schwab, Fidelity Digital Assets and Citadel.

Still, the crypto market has recently come under regulatory crackdowns that could complicate bitcoin's rally.