Fed Week Is Here Again | The Investors Edge

By John Stewart, chief investment officer at Farmers Trust Co.

Week in Review:  Revenge of the Bulls

CANFIELD, Ohio — After an absolutely brutal first half of the year for stocks, the bulls fought off another scorching inflation report last week to mount a decent rally over the past several trading sessions.

Participation was rather broad across the market spectrum, but the upside has been led primarily by growth stocks in the technology, communications, and consumer discretionary sectors.

There are plenty of reasons being pointed to for why stocks have rallied off their lows – falling commodity prices, peak pessimism, short sellers covering bearish bets, and better than feared early second quarter earnings results are just a few of the possibilities.

What comes next is anyone’s guess, but we’ve seen this show several times already this year. This is the third time that stocks have rallied more than 10% off their lows, only to succumb to further weakness as the overall trend continues lower.

That downward trend is still in place, and we continue to recommend investors stick with relatively defensive positioning until there is an improvement in the trajectory of earnings estimate revisions – which, for now, continue to weaken.

Featured Insight:  Watch What They Do, Not What They Say

I was trained early on in my investment career that market sentiment was a powerful tool in making good investment decisions.

That is because investing is a game of expectations – it doesn’t matter whether an earnings report is “good” or “bad” in an absolutely sense – it only matters what the report is relative to what was expected. Pessimistic sentiment equals low expectations, which are easier to beat, and vice versa.

While this type of behavioral analysis was just beginning to attract attention 20 years ago, it is now fairly well understood by the majority of mainstream investors. All kinds of sentiment surveys are now available to gauge whether investors are “bullish” or “bearish”.

Currently, most of those surveys are showing extreme levels of bearishness across the investment landscape – meaning, when asked, the majority of investors say that they are bearish.

When you look at what investors have actually done with their money, however, it paints a bit of a different picture. So far this year, flows into equity mutual funds have been quite strong with only some rather modest outflows in recent weeks.

We may need to see more bearish ACTION – that is, SELLING – before the market can put in a bottom.

Looking Ahead: Fed Week is Here Again

We have another Fed week on deck next week, and expectations are firmly set on another three-quarter point hike in the Fed Funds rate – there was brief discussion on the possibility of a full percentage point hike, but that seems like a long shot at this point.

Markets seem to have come to grips with the fact that the Fed will continue hiking interest rates in an attempt to reign in inflationary pressures – it is now just a question of whether inflation moderates before tighter monetary policy breaks the economy.

Stocks have already discounted some pain – so like I just mentioned before – it is a question of what is going to happen relative to what are already rather pessimistic expectations.

At this point, it seems unlikely the Fed will be more aggressive that what is already expected, so perhaps the stock market rally can continue at least through the end of this month.

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