The S&P 500 is poised to fall sharply as investors flee risks assets on fears over a recession, aggressive tightening by the Federal Reserve and the hottest inflation in four decades, according to Morgan Stanley analysts.
In a Monday note to investors, Morgan Stanley analysts, led by Michael Wilson, warned the S&P 500 appears “ready to join the ongoing bear market.” The index has plunged in recent weeks and extended a sharp selloff on Monday as worries over a potential COVID-19 lockdown in China rattled investors.
FED RAISES INTEREST RATES FOR FIRST TIME IN 3 YEARS, PROJECTS 6 MORE HIKES AS INFLATION SURGES
In the past month, the benchmark S&P index has dropped about 6.6%. It is down about 11.1% so far this year.
“With defensives the latest big outperformer, they are now expensive, leaving very few places to hide,” Morgan Stanley analysts wrote in a Monday note. “This suggests the S&P 500 will finally catch up to the average stock and enter a bear market.”
They said the increasingly hawkish Fed is looking “right into the teeth of a slowdown,” and that there is little upside for defensive positioning lately.
“The market has been so picked over at this point, it’s not clear where the next rotation lies. In our experience, when that happens, it usually means the overall index is about to fall sharply with almost all stocks falling in unison,” the analysts wrote.
The note comes amid growing fears that the Fed could inadvertently trigger an economic downturn as it takes a more hawkish approach to fighting inflation, which is at the highest level since December 1981. Policymakers raised rates by a quarter-percentage point in March, and have Since signaled that sharper, half-point increases are likely in the coming months, beginning in May.
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“It is appropriate to be moving a little more quickly,” Fed Chairman Jerome Powell said last week during a panel discussion at the International Monetary Fund and World Bank spring meetings. “I also think there’s something in the idea of front end-loading whatever accommodation one thinks is appropriate. So that points in the direction of 50-basis points being on the table.”
Traders are now pricing in a 100% chance of at least a half-point rate jump when policymakers meet on May 3-4. It would mark the first time since 2000 that the US central bank raised the federal funds rate by 50 basis points.
Some economists believe the Fed waited too long to confront the burst in inflation, while others have expressed concerns that moving too quickly to stabilize prices risks triggering an economic recession. Hiking interest rates tend to create higher rates on consumer and business loans, which slows the economy by forcing employers to cut back on spending.
Powell has pushed back against concern that further tightening by the central bank will trigger a recession and has maintained optimism that the Fed can strike a delicate balance between taming inflation without crushing the economy.
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Still, he acknowledged the difficulty of the task ahead and said it is “absolutely essential” for central bankers to restore price stability.
“Our goal is to use our tools to get demand and supply back in sync, so inflation moves back into place, without a slowdown that amounts to a recession,” Powell said. “I don’t think you’ll hear anyone at the Fed say that’s straightforward and easy. It’s going to be challenging.”