Investors should be prepared for increased volatility in the stock market over the next few months, according to James McCann, deputy chief economist at abrdn. This comes after the Federal Reserve recently raised rates to a range of 5.25%-5.5%, the highest level in over two decades.
Cautious Approach to Equities
“We have a cautious stance on equities,” McCann stated following the quarter-point rate hike by the Fed. Despite expectations of future rate increases, he also mentioned that there might be a possibility of further hikes in the coming months.
A Pessimistic Macro View
McCann noted that abrdn, which manages approximately $452.4 billion in assets, holds a more pessimistic macro view than some others in the market. They believe that a U.S. recession is more likely to happen within the next year.
Stock Market Performance
Despite some regional bank collapses earlier this year due to the rapid pace of rate increases since March 2022, stocks and other risky assets have generally experienced positive growth. However, the anticipated U.S. economic downturn has yet to materialize.
Recent Market Closes
On Wednesday, stocks closed mostly lower, with the Dow Jones Industrial Average (DJIA) ending 3.5% off its record close in January 2022. The S&P 500 index ended slightly lower, down 4.8% from its last record close, and the Nasdaq Composite Index shed 0.1%.
Fed Chair’s Comments
During an afternoon press briefing, Fed Chair Jerome Powell acknowledged the progress made but emphasized that the fight against inflation is far from over. He also indicated that future rate hikes will be determined on a meeting-to-meeting basis.
Possible Future Rate Hike
Powell mentioned that another rate hike in September is certainly possible but also suggested that a pause might be an option depending on how confident central bankers are regarding inflation receding to the Fed’s 2% annual target.
A Closer Look at Inflation and the Market
The consumer-price index, a key gauge of inflation, has seen a significant drop in July, coming in at a 3% annual rate. This is a considerable decrease from its peak of 9.1% last year. Much of this decline can be attributed to the decreasing costs of oil, homes, food, and cars as they have returned to pre-pandemic levels. Despite these fluctuations, certain sectors of the economy, such as housing, have remained relatively resilient.
Federal Reserve Chairman, Jerome Powell, has emphasized the importance of controlling areas of inflation that are more difficult to manage. He recognizes the robust state of the labor market, with an unemployment rate at 3.6%. Powell appreciates the positive aspects this brings but assures that the Fed has no intention of pushing more people out of work through rate hikes. Historical trends suggest that rate-hiking cycles tend to coincide with a softening labor market.
Waiting with Rewards
Amar Reganti, a fixed-income strategist at Hartford Funds, was particularly struck by Powell’s recent statements regarding the Fed’s willingness to tolerate increased unemployment in order to tackle inflation. Despite rising default rates in certain population segments and other areas of the economy, Hartford Funds, managing approximately $127.2 billion in assets, still views the U.S. consumer as being strong.
Reganti argues that fixed income, unlike stocks, has the potential to provide a substantial source of income for investors even during a recession. The 2-year Treasury rate had dropped to 4.825%, down from its March peak of 5%, while the 10-year Treasury yield was currently at 3.85%, a decrease from its high of 4.231% in October.
According to Reganti, market participants are now being rewarded for their patience as they wait for economic data to unfold. This is a significant shift, as just a few years ago, such an argument would have been difficult to make.