Investors can fight the Fed all they want. Don’t fight the tape

(Bloomberg) — Ignoring the Federal Reserve’s determination to keep raising rates and keep them on Wall Street is now a hugely profitable trade. He is trying to swim against a rising market that carries risks.

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“Fighting the Fed” has been a winning stock market strategy for months now. The S&P 500 is up 15% since the start of the fourth quarter and up 16% from its October low, putting it in close proximity to the 20% threshold that many investors define as the start of a bull market.

Meanwhile, the central bank has raised rates three times, says more hikes are coming, and keeps insisting it’s going to keep the federal funds rate high for a while. But there was a reaction in the stock market, who cares?

There appears to be a bet that these increases were priced into stocks and that the Fed will indeed be able to make a soft landing, curbing inflation as the economy continues to grow. And that puts rate- and inflation-averse traders in the predicament of head-butting into the prevailing market momentum.

“What if the Fed really wins? It looks like it is,” said Adam Sarkhan, founder of 50 Park Investments, which is long US stocks, including battered tech stocks like chip stocks. “Investors are rewarded when they join the main trend on Wall Street. Never fight the tape and keep your losses small.”

Of course, the risk facing the herd of bullish investors was clear in Friday’s gangster employment report – the possibility of stubbornly high inflation. If a healthy labor market supports wage growth, prices may not come down. And it will prevent the Fed from suspending its most aggressive tightening cycle in decades.

Bullish Sectors

One of the hopeful factors for stock optimists is a change in market leadership. Sectors leading this year’s recovery, such as discretionary consumer goods and information technology, have historically outperformed in the early stages of bull markets, according to investment research firm CFRA. The same goes for stocks of materials, which have shown growth since the end of September.

History also suggests that a recession, or lack thereof, will be critical for stocks. Since World War II, there have been nine bear markets that have been accompanied by recessions, and on average the S&P 500 is down 35% compared to 28% for bear markets that have not been accompanied by economic downturns, CFRA data shows.

What is particularly interesting is that since 1948 there have been only three bear markets without recessions. And each time, a new bull market began within five months of the stock price drop.

Sam Stovall, chief investment strategist at CFRA, sticks to his bullish outlook on US equities, even as he thinks a shallow recession could still happen. His S&P 500 12-month rolling target of 4575 points is 11% higher than Friday’s close.

“Can we expect a more severe bear market, or will there be a very mild decline this year and the stock market has already bottomed out?” Stovall said. “I believe we are in a new bullish phase.”

Stovall is right. For stocks, even in a recession, length really matters. According to Gina Martin Adams, chief equities strategist at Bloomberg Intelligence, the depth of real GDP’s fall from peak to trough has not historically correlated with the severity of moves in stock markets. But shorter recessions led to a faster recovery.

Analysts polled by Bloomberg predict the economy will contract in the second and third quarters of this year before recovering later in the year.

technical rule

Even die-hard bears are getting more optimistic — for now.

Doug Ramsey, chief investment officer of the Minneapolis-based Leuthold Group, said the firm increased its equity investments earlier in the year. While he believes the US could enter a recession later this year, he currently plans to participate in the latest rally based on improved technical numbers.

“Historically, the opportunity to make money in stocks has been between the initial inversion of the yield curve and the peak of stocks before a recession,” Ramsey said. “It seems risky for many. Some might think it’s like trying to grab a few nickels in front of the ice rink, but I’m not sure if that’s the right thing to do. We could collect gold coins in front of the tricycle and that could be useful.”

In the long run, Ramsey fears a fake head. Sectors that do well in a soft landing scenario are often similar to those that do well in the run-up to a recession. Materials and manufacturing companies, for example, two value sectors that have weathered this year’s growth rally well, typically do well in the six months leading up to a downturn.

Naturally, long-term optimists don’t look at this. For them, a recession is becoming increasingly unlikely, and inflation is declining, which is what the Fed wanted to do. So the arrow is up, and it makes little sense to fight the tape.

“Inflation is coming down and we don’t have the threat of a major recession,” said Sarkhan of 50 Park Investments. “From what I understand, the bear market is over in every way.”

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