S&P 500: Fed Policy Remains Favorable For Stock Prices

The S&P 500/SPX took a nosedive last week, as the Fed signaled some tightening could occur in 2023. The Federal Reserve now forecasts at least two rate hikes by the end of 2023, and some FOMC members see the possibility of a rate increase as early as 2022. However, Jerome Powell indicated that the Fed's dot-plots "should be taken with a big grain of salt." Nevertheless, market participants decided to sell stocks and ask questions later, as the SPX futures cratered by 3% in recent days. This renewed volatility has led to uncertainty, and some market participants are now asking if a more significant selloff is in store.

SPX futures: 5-day chart

Source: thinkorswim

Just seven of the 18 FOMC members anticipate a possible rate increase sometime in 2022. These members represent a minority, as most don't believe a rate hike is appropriate until 2023. Moreover, five of the members don't think a rate increase should occur until after 2023 expires. Thus, we are likely looking at an ultra-easy zero-rate environment for another two years or so. Additionally, Fed Chair Powell indicated that the dot-plot trajectory is not conclusive, and the Fed could alter its liftoff date if necessary. This statement implies that the Fed could wait longer than anticipated to taper, and inflation could progress higher than expected in the meantime. With economic growth and inflation rising and the probability of notable interest rate increases years away, the market is likely going through a healthy, transitory pullback process. Therefore, the recent weakness in the S&P 500 and stocks, in general, is most likely a buying opportunity.

Recent Economic Data

We continue to see solid economic readings roll in. This month, ISM manufacturing PMI moved up to 61.2, and ISM non-manufacturing PMI came in at 64 (data for May). Average hourly earnings came in higher than anticipated, and the unemployment rate fell by more than expected. CPI and PPI inflation also topped estimates. Consumer expectations along with consumer sentiment numbers surpassed analysts' estimates. Now, all this positive data is further supported by substantially higher than expected declines in oil inventories. Naturally, all numbers cannot be perfect, and there were several slight misses. However, these small inconsistencies are explainable by month-to-month variations. Nevertheless, the general image seems clear; the economy continues to expand, demand is robust, and growth is not likely to cease any time soon.

Valuation Perspective

With the Shiller P/E ratio approaching 37, the S&P 500 is not cheap here. However, it is crucial to consider that we are in the most accommodative economic environment in history. Companies are still recovering from the extraordinary coronavirus-induced lows. Also, if we look at estimates, the S&P 500 is trading at about 22 times next year's earnings expectations, notably lower than the 27 P/E ratio the SPX traded at 1 year ago. While estimates seem generous, I see no reason to doubt consensus earnings projections in this high growth, inflationary environment.

Technical View

SPX futures 4-hour chart

Source: thinkorswim

Thus far, we've seen about a 3% pullback in SPX futures. This decline is very much like numerous previous declines of several percent that we've witnessed in past months. Moreover, there is nothing abnormal here from a technical standpoint, and the fundamental backdrop remains very attractive.

SPX futures 1-hour chart

Source: thinkorswim

Here is a close-up view of SPX here. We see a bit of volatility post-Fed meeting, but nothing that suggests substantial declines are ahead. SPX futures can form a constructive reverse head and shoulders pattern here or retest the recent low to build out a W-shaped bottom in a base case scenario. SPX futures could decline to around the 4,000 level, around a 5% correction in a worse case. However, it may be too early to consider this outcome, as it will only become probable if SPX futures decisively penetrate 4,125 support. Key resistance is around 4,180-4,200, then higher around 4,220 after that. Crucial support now is 4,125-4,100, then 4,050-4,000 after that.

The Bottom Line

We are long a diversified basket of stocks, gold/silver/miners ("GSMs"), and digital assets. While the Fed has enabled some volatility to enter markets, I do not expect that this will create a prolonged downturn for major stock averages, commodities, and risk assets in general. Instead, this transitory downturn is likely a buying opportunity for intermediate and long-term-oriented investors.