The Fed will 'push the market off the cliff' and the U.S. stock pullback may have begun

Source: Barron's Chinese

As the stock market continues to clear excess liquidity, investors should be prepared for further declines, as the long-stretched rubber band finally breaks.

The calm forecast made by the Federal Reserve on Wednesday (December 18th) regarding interest rates and inflation prospects for 2025 has had an impact on the market. The market may have started a correction, but it is not yet time to panic.

Fed Chair Powell conveyed a message that nobody wants to hear: the process of declining inflation is slower than expected, and it is expected that there will only be two interest rate cuts of 25 basis points each in 2025. Compared with the previous more significant interest rate cut forecasts and expressions of making more progress in reducing inflation, the signal released by Powell on Wednesday disappointed investors.

After a 25 basis point rate cut on Wednesday, the federal funds target range dropped to 4.25%-4.5%, but there was significant internal dissent within the Fed about the rate cut, with four officials opposing it.

Influenced by the hawkish tone of the Federal Reserve and Powell's speech, the S&P 500, Dow Jones Industrial Average, and Nasdaq Composite Index all fell. The S&P 500's 3% drop on Wednesday was the largest decline on the day the index announced the Fed's interest rate decision in nearly 15 years. The Dow fell by 2.6%, marking its 10th consecutive trading day of decline. The Nasdaq dropped by 3.6%, marking its worst performance on the day of the Fed's interest rate decision since March 2020.

Interest rate-sensitive small-cap stocks have been hit harder, with the Russell 2000 index falling 4.4%. At the same time, market volatility has surged, with the VIX panic index soaring 74% to 27.62, marking the largest single-day percentage gain since February 2018, according to Dow Jones Market Data.

VIX Panic Index Soars

Bonds were not spared either, with the 10-year US Treasury yield soaring to 4.5%. In the past eight trading days, the 10-year US Treasury yield has risen on six of them, increasing by 0.87 percentage points from the 52-week low of 3.62% set in September.

10-year US Treasury yield rises to its highest level since May 31

The information conveyed by Powell is not so sensational, but because the market is already on the edge of a cliff, it does not take much force to push it off the cliff. BTIG technical analyst Jonathan Krinsky wrote in a research report on Wednesday, "Today, the already tense rubber band broke."

Kremlin noticed that the technical indicators of the stock market have been "exhausted": the number of declining stocks has exceeded the number of rising stocks for 13 consecutive trading days, and only 8% of the stocks in the S&P 500 index components are above their respective 20-day moving averages. In addition, Adam Turnquist, chief technical strategist at LPL Financial, pointed out that currently only 53% of stocks are trading above the 200-day moving average, at a yearly low.

Krebsky pointed out that high-momentum stocks had been close to collapse before, and this finally happened on Wednesday: high-momentum stocks fell nearly 6%, experiencing their worst day since May 2022.

As the stock market continues to clear excess liquidity, investors should be prepared for more declines. Strategist Ed Yardeni wrote in a research report: "Today's turbulence in the financial markets following the Fed's hawkish rate cut may be the beginning of the correction we have been expecting."

At the same time, investors have not been blindly selling. Tesla (TSLA) fell by 8.3%, but Nvidia (NVDA) had a relatively small decline of 1.1%, reflecting a significant drop in the company's stock price in recent trading days.

In addition, UnitedHealth (UNH) is the only component stock in the Dow that rose, up 2.9%. Other health insurance companies also rose, including Cigna (CI), Centene (CNC), and CVS Health (CVS). Since the murder of an executive at UnitedHealth, the healthcare sector has been declining, and investors seem to think that all the negative news has been priced in.

Investors still have ample reason to expect the market to digest and respond to the more pessimistic outlook given by the Fed. First, Powell reiterated that the US economy remains healthy. Second, the inflation rate fluctuates in the range of 2%-3%, making it difficult to further decrease, but it is not as bad as a significant increase in inflation, which was the main cause of the stock market being sold off in 2022. Finally, there is currently no sign of a decline in corporate profits.

It is also worth noting that the stock market is still far from a correction (at least a 10% decline) at present. The S&P 500 index closed at 5872 points on Wednesday, only down 3.6% from the historical closing high of 6090 points reached on December 6th.

When technical indicators deteriorate as they have recently, they may take some time to recover. Klynski pointed out that he could not rule out the possibility of further declines in the stock market, expecting a "larger and longer-lasting decline" in early 2025.

However, corporate profits still have many supporting factors. At the same time, Trump's proposed relaxation of regulations and tax reduction plan are expected to bring some stimulus to the growth of the U.S. economy, and help corporate profits continue to grow (provided that tariffs do not cause the U.S. economy to deviate from the growth path and inflation to soar again).

Adrian, who has always been bullish, has not changed his stance. He wrote in his research report, "Government shutdown, dock workers' strikes, Trump's imposition of tariffs on the first day of his new administration, and other issues are worrying, which may lead to continued stock market downturn until January next year. However, we still give a target price of 7000 points for the S&P 500 index at the end of next year."