Markets expect the Federal Reserve to signal a series of interest-rate cuts when the agency announces its monetary policy decision Wednesday. The Fed could disappoint, however, and many stocks could falter.
Consider the drop in bond yields. The two-year Treasury yield is down to 4.3% from a multiyear peak of roughly 5.2% set in October. The bond market expects the Fed to cut short-term rates beginning in March in the face of subsiding inflation. Lower rates can continue to stoke economic growth.
That all has boosted stocks. The
Invesco S&P 500 Equal Weight
exchange-traded fund is up about 19% to $158 from a multi-month low point hit in October. The ETF weights each stock in the index equally, stripping out the outsize impact of Big Tech companies such as
Apple,
Amazon,
and
Meta Platforms,
which happen to be reporting quarterly earnings this week.
The equal-weighted S&P 500 already reflects high expectations for changes in Fed policy. Like the conventional
S&P 500,
the component stocks of the ETF have surged, but could drop if the Fed doesn’t signal the number of rate cuts as markets hope for, especially since inflation remains a tick above the Fed’s 2% target.
“If the Fed really is serious about only two or three rate cuts in 2024, then the statement should forcefully push back on the idea of a rate cut in March,” wrote Sevens Report’s Tom Essaye. “Likely Market Reaction: A solid decline.”
That would come as no surprise, especially because many stocks are hitting “resistance”—prices at which investors sell, knocking shares lower. The ETF peaked at about $162 in late 2021, and since then has repeatedly failed to break above the high $150s. In order to break through that resistance, something must change for the better, such as the Fed aggressively lowering rates. Anything short of such validation, and stocks will struggle this week.
There’s little middle ground. Stocks have elevated valuations, and investors are too optimistic rates will drop. A combination like that carries downside risk in the event of even mild disappointment.
The ETF trades now at about 16.2 times analyst’s aggregate earnings estimates for the coming year, a discount to the standard S&P 500’s 20.2 times, but the equal-weighted index has traded to as low as about 13 times in the past few months. The multiple could drop this week if markets are forced to anticipate a less-rosy picture for rates and the economy.
Brace for some downside as the market digests what the Fed says.
Write to Jacob Sonenshine at [email protected]
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