The stock market is crushed again. It is now more likely to revisit its recent bottom.
Friday is experiencing its fourth consecutive day of declines. It is now down about 13% from the mid-August high of a summer rally. An important driver: persistently high inflation is forcing the Federal Reserve to raise interest rates on federal funds at a rapid pace. This week, the Fed indicated that the ‘peak’ rate for fed funds is above 4.5%, slightly higher than previously expected. The Fed is trying to lower inflation by reducing economic demand, so the problem for the stock market is that the economy could take a hit – and so could corporate profits.
All this has brought the market to a dangerously low level. The S&P 500 fell below a level slightly above 3800 this week – it is now at a check mark below 3700. That’s the key; at just over 3800, buyers had recently stepped in a few times to support the index. Those buyers have left because confidence in the market outlook has faded. With the index more in a downtrend, “failure to hold”  is a major change of character for the market, increasing the likelihood of a rapid decline to the June lows,” John Kolovos, chief technical strategist at Macro Risk Advisors, wrote in a research report.
Speaking of that June low, the market is certainly flirting with revisiting it. The lowest point during the year is 3636, reached in mid-June. The possibility of the S&P 500 going back to that level is terrifying, not only because it represents a small loss from here, but also because at that point traders should be hoping it can buy “support” there. If the index goes below that level of support, the next level of support is about just below 3500. That represents a loss of about 5% from here.
That’s the bad news, but don’t give up hope just yet. There is still an upward scenario. If the index can find support near its lows, it could experience an “impulsive rally” past the 4100 area, Kolovos wrote. That’s where a brief rally from early September ended — and sellers stepped in. Buyers at that level would mean the market becomes more confident.
Indeed, there could be some positive developments to push the market back up. The most important development would be that the Fed will not really push the Fed Funds rate above 4.5%. Historically, the Fed often doesn’t raise rates all the way to its projection, Sevens Report Research noted. In 2015, the Fed predicted that the Fed Funds rate would rise to just over 3% in a few years. In 2019, it peaked at around 2%. That’s because interest rates are rising as the Fed’s rate-raising campaign gets underway, reducing borrowing and spending. Then economic growth slows and the Fed pauses with rate hikes.
“If the economy starts to slow significantly in the coming months, history implies that the Fed… will have to lower its expectation of terminal funds,” wrote Tom Essaye of Sevens Report.
That would probably put a floor under economic growth forecasts. The gains, while taking a hit, may not fall to catastrophic levels. The market can then look ahead to better days, when economic growth and earnings growth can be reliable.
The point is that the market is at a crossroads and the next few trading days will be crucial.
Write to Jacob Sonenshine at [email protected]