- A survey showed investors believe the Fed will provide more support if the S&P 500 falls to 3,700.
- But some believe that the level may be lower than this if it is present.
- The stock has had a volatile start to the year, with the S&P 500 down more than 8.5% since January 3.
On CNBC’s “Fast Money” on February 1, Metropolitan Capital Advisors CEO Karen Feinerman used a metaphor to describe how investors have become conditioned to incentives.
“I think we’re college kids who have moved home and we expect the Feds to cook for us, clean up, and we don’t have to do anything,” Feinerman said. “Well, now the Fed is saying, ‘Yeah, look, I’m not doing anything anymore.'”
Investors are indeed facing growing pains as they begin to swallow the reality of the Federal Reserve adopting its stimulus measures. To start the year, the S&P 500 is down 11.9% and the Nasdaq is down as much as 18%.
But for many investors, even if the extraordinary support is fading, there is a safety net: a concept known as a Fed put.
The idea is that if stocks take a big enough blow that foreshadows an economic crisis, the Fed will step in and start providing external incentives again. It is considered a product of the Fed’s own work, as the central bank has consistently reassured investors that it will continue its full support as the US economy recovers from the effects of the COVID-19 pandemic.
Right now, according to a Bank of America survey of hundreds of fund managers, investors believe a Fed put will come into play if the S&P 500 drops to around 3,700. It is down 16% from Friday’s close of 4,384 and 23% below its record high.
Bank of America
No More Fed Put
But according to some on Wall Street, the concept of a fed put is no longer in vogue.
Bank of America’s own Savita Subramaniam is one who thinks the Fed’s support for stocks is a thing of the past, at least for now. The bank’s chief US equity and quantitative strategist has said the central bank will not step down as it focuses on other things – namely full employment and an orderly financial system.
“I think the Fed’s put is gone. I don’t think the Fed has market support. I mean, the S&P 500 isn’t one of their double mandates,” Subramaniam said during an inside webinar on Wednesday. “I don’t think we’re in the same environment we were in four or five years ago where the markets would throw a taper tantrum and the Fed would stop hiking. I think it’s a very different environment from where we are today.”
Subramaniam continued, “I don’t think I see the Fed reacting to the equity market alone.” “Their job is not to hype the S&P 500. It’s interesting to hear the Fed speak — some of the Fed members are actually speaking out about the bubbles we’re seeing in the stock market.”
Credit Suisse chief US equity strategist Jonathan Golub concurred with Subramaniam during the webinar.
“Savita, I couldn’t agree more,” said Golub. “First of all, I don’t even want the Fed to respond to the stock market. I want them to do their job.” The Fed’s mandate from Congress is to maximize employment, control inflation, and moderate long-term interest rates.
Both agreed that the credit market would have to crash for the Fed to step in.
While both Subramaniam and Golub think the Fed has little will to step in and defend stocks in the event of a major crash, others think the Fed wouldn’t be able to save them, even if they intervened.
John Husman, president of the Hasman Investment Trust, which called the stock market crashes of 2000 and 2008, said in a recent comment that he believes investors mistakenly consider support from the Fed as something that “mechanically from” supports the market.
Instead, he said, it supports investor psychology. And once sentiment turns bearish, it will be harder for the Fed to halt a recession in short order, he warned.
Shares continued to fall 50% in 2000 and 2008, even after stepping in with support from the Fed, he said. Furthermore, he highlighted that when the internals of the market are unfavourable – as they are now – monetary easing has not helped.
“Fed easing has not reliably supported stocks over a period when investor psychology has shifted toward risk-averse,” Hasman said. “It’s a gap that many investors are likely to overlook, with disastrous consequences as this Fed-induced yield bubble is seeking to collapse.”
Tom Essay, founder of market-research firm Sevens Report Research, who is also a former Merrill Lynch trader and a former hedge fund founder, has a bit more nuance.
In a normal environment, the essay still assumes that a Fed put exists, and that 3,700 is probably close to the Fed’s move.
But things change when increased inflation comes into play, he told Insider on Friday. If inflation remains high, around 4% or so, the essay warned that the central bank’s hands could be tied, and the Fed could drop below 3,700. Essay said he expects the structural issues driving inflation to persist over the next year, and that inflation will remain at 3-4% at that time.
“If we drop to 3,700 on some sort of a deadlock, negative environment, it could be lower, because the Fed won’t be able to cut rates until they get inflation back closer to 2%,” he said. Bring it,” he said. “If the CPI is running above 4% a year, and every politician in the world is screaming that inflation is killing their constituents, the Fed won’t be able to get worse.”
In general, given the increased inflation, the essay said that Fed puts would require a larger decline than in recent years. Richard Fischer, former chairman of the Dallas Fed, takes the same stance.
In such volatile periods, it is difficult to know how the Fed will react to the markets.
Stocks are part of the broader economy, and if large amounts of money are wiped out in a major pullback, it will begin to take effect. This concept is known as the negative money effect: when a significant portion of one’s wealth decreases, their spending habits become more conservative, and vice versa.
But if inflation is already hitting the economy, the Fed may have no choice but to ignore the stock market decline.
Michael Leibovitz of RIA Advisors touched on the fine line for moving the Fed in a recent commentary.
“The Fed is making it clear that they want to reduce inflation. They are also telling us that they will ensure financial stability. Sounds like a good plan, but successfully achieved by achieving low inflation without destabilizing the markets It’s an incredibly difficult task to walk the narrow trajectory.”
“We think the odds of success are slim. As such, we must carefully consider which goals they will prioritize when pushed.”