The Federal Reserve raised interest rates by a quarter of a pct, as expected, and at the same time lowered growth forecasts for the US economy next year, an uncomfortable mix for equity markets. The S&P rally, earlier in the day, once again went into reverse, as Jerome Powell did not provide the more dovish tone that the market had hoped for. According to the Financial Times, last night’s reaction to the Fed rate hike was the worst by equity markets in over two decades.
The global equity market, as measured by the World MSCI, has fallen circa 15% from its peak earlier in the year. Not quite bear market territory, but pretty close. The US equity market has fallen 16% from its high. Likewise, European equities a similar amount. This rather implies that equity investors had come to the conclusion ahead of the Fed, that the expectation for US growth next year had become optimistic. Equity markets in Europe opened lower by circa 2% on Thursday before staging something of a recovery. Could this latest leg down be the last capitulation move equity investors need for the market to start to recover? The Vix index was unchanged on Wednesday despite this increased uncertainty. Suggesting either investors are confident we are close to capitulation or are being complacent of the outlook. However, it did climb again on Thursday, close to 30, still, below the extremes, it made earlier in the year.
October through to mid-December has been a miserable time for equity markets as it has reacted to a lowering of earnings growth expectations and weaker economic data. On the positive side the Fed did suggest going forward they are likely to slow the rate of further hikes into 2019. As we pointed out the other day analysts remain optimistic for next year, but they have been known to be wrong on more than one occasion.
The recovery from the lows on Thursday helped by the expectation that US equities will open higher may suggest the Fed last night flushed out the last of the fast money. In the end, US equity markets continued to sell off at the open. Merrill Lynch’s latest fund manager survey suggested investors were getting closer to the point of capitulation. Bad news for so long has been bad news for equity markets over the past months. If the Santa rally is to occur it's going to be jolly late coming.
This will be the last missive before the New Year as we lick our wounds to a year that finished very differently for equity investors than how it was forecast.