(Bloomberg) — US stocks are nearing a record high and only US corporate prospects are expected to brighten. Investors are now waiting to see if the Fed derails the market’s bullish path.
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Amid signs that inflation pressures are finally easing, which has historically been a bullish extension, the S&P 500 is just 5.4% below its all-time peak. It is a backdrop that increases the stakes for this week’s pivotal central bank meeting, as economists are still debating whether a recession is coming this year.
The risk, of course, is that a flexible labor market prompts policymakers to signal further tightening beyond an expected rate hike this week, putting Wall Street’s earnings outlook at risk, especially for high-tech stocks that have been key to this year’s advance.
“The risk is if the Fed feels compelled to re-accelerate the tightening cycle,” said Ed Clissold, chief US strategist at Ned Davis Research. “If that’s the case, it could end up being the policy bug everyone has been looking for.”
Investors are preparing for a huge week on two fronts. About 170 companies in the S&P 500, which account for about 40% of their market capitalization, are scheduled to report earnings, including Microsoft Corp. and Meta Platforms Inc. and Alphabet Inc. Google’s parent company.
Read more: Netflix, Fed Cast Clouds over Tech-Stock Surge: Earnings Watch
However, Wednesday could prove decisive, as the Fed is expected to raise its benchmark interest rate to a 22-year high, followed by Chairman Jerome Powell’s press conference. The central bank chief could tip the chance of a further rally, a scenario that risks locking out the brakes on growth and the volatility of the bulls.
“I’m on the defensive because I still think we’re heading into a recession,” said Brian Frank, portfolio manager at Frank Value Fund. “An economic downturn tends to take everyone by surprise because people first deny it by calling it a ‘soft landing’ and then we end up with a recession after that.”
Housing assistance
But for Dennis Debucherie, founder of 22V Research, signs of strength in housing run counter to the bears’ argument.
Sentiment of US homebuilders rose in July to a 13-month high. This is good news for investors who are awaiting an advance reading of Q2 GDP this week.
“The most interest rate-sensitive sector, housing, has already stabilized and is a support for GDP growth (mechanistically, given last year’s massive housing drawdown),” Debuschery wrote in a note. “If the most rate-sensitive sector is improving, it is difficult to rely on the late effects of tightening to justify bearish views.”
The GDP report is expected to show that the economy grew at an annual rate of 1.8% in the most recent quarter, compared to 2% in the previous reading, according to a Bloomberg poll.
On Friday, traders will be watching the Employment Cost Index, a broad measure of wages and benefits, along with the Personal Consumption Expenditure Price Index — the Fed’s preferred measure of inflation — which will help determine whether the central bank will start to favor another rate hike at its September meeting.
For now, what investors know for sure is that the earnings outlook keeps getting better. While earnings for the S&P 500 companies are expected to decline for the third consecutive quarter, earnings improve when excluding the energy sector, the only S&P group that will have strength in 2022, according to Bloomberg Intelligence data. BI data indicates that earnings growth is expected to return without energy in the second half of the year.
“Earnings have improved dramatically over what the stock market was priced in late last year,” said Gina Martin Adams, chief equity strategist at BI. “Using economics as a stock market forecasting tool is proving to be a really shady business.”
— With assistance from Nora Molinda.
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