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The Fed’s strict message reinforces concerns about stock values

The prospect of faster-than-expected money tightening has rattled Wall Street, dragging the S&P 500 deeper into the bear’s territory on Tuesday and forcing investors to reconsider a stock market that does not look cheap even after its dramatic sale.

It has been an ugly period in the markets, reflecting concerns about how the economy will hold up when the Federal Reserve embarks on its sharpest campaign for interest rate hikes in decades. Investors expect an increase of 0.75 percentage points on Wednesday, which will be the largest since 1994.

Shares were mixed on Tuesday, with the Dow Jones Industrial Average falling 152 points, or 0.5%, and the Nasdaq Composite Index up 0.2%. The Nasdaq and S&P 500 are in a bear market, defined as a decline of at least 20% from their peaks.

Many investors claim that the worst in the markets may soon be over, given the prolonged downturns in many market sectors this year and the generally healthy state of the US economy. They say that the purchase of dip has fallen out of favor during this year̵[ads1]7;s route, but that negative sentiment is often a precursor to an extended rebound.

But even many optimists in the stock market admit that an upturn will have to face some significant obstacles, first and foremost the still high level of valuations, which over time tends to be one of the strongest factors in predicting market developments. Even with the S&P 500 down 22% in 2022, many investors and analysts fear that stock market values ​​will fall further. On Monday, the S&P 500 traded at 15.8 times its estimated earnings over the next 12 months, according to FactSet, still above the 15-year average of 15.7.

Raising interest rates on Wednesday by a larger 0.75 percentage point, or 75 basis points, could be a way for the Fed to catch up with an increase in inflation that has been far higher and sustained than officials expected. Evidence that targets for inflation expectations from companies and households will increase over the long term will be particularly alarming at the central bank.

“My feeling is that the Fed has decided to use 75 basis points instead of 50 basis points because of the data we have received over the last week or so showing higher inflation and perhaps some more disturbing news about inflation expectations,” the former New York spokesman said. Fed President William Dudley at The Wall Street Journal CFO Network event Tuesday.

Mr. Dudley said that the same arguments for an interest rate increase of 0.75 percentage points could be used to argue for a one percentage point increase “because if you decide that the speed of getting there is as important as the level you are getting to, why not get there faster? ”

But he said he expected officials to “probably split the difference” by choosing instead of 0.75 percentage points.

Analysts who carefully analyze the central bank’s policy were divided on Tuesday as to whether the potential costs outweighed any benefits of switching to a more aggressive interest rate increase of 0.75 percentage points from the half-point interest rate increase expected before the latest inflation reports.

The Dow Jones Industrial Average fell 0.5 percent on Tuesday while the Nasdaq Composite rose 0.2 percent. Some worry that the Fed’s tightening could push the economy into a recession.


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Some warned that the central bank, by recently giving unusually precise guidelines that it would raise interest rates by half a percentage point this week, risked creating greater confusion in the financial markets. Krishna Guha, deputy head of Evercore ISI, said in a note to customers on Tuesday that he was concerned that the 0.75-point rate hike “is not embedded in a credible and systematic political strategy and without this risks looking like a panic reaction. .. which may not age well. “

Mr. Guha, a former adviser to the New York Fed, said such a move created a “serious morning-after-problem” by inviting difficult answers to questions about what the Fed would do next.

Economists at Deutsche Bank said they expected the Fed to raise interest rates by 0.75 points again at its July political meeting, which would put the Fed on track to raise interest rates much closer to levels designed to actively slow the economy by the end. of this year.

The Fed’s campaign to curb inflation is increasing the dynamics that governed the stock market in recent years, as interest rates on the bottom drove investors to seek returns on risky assets. The popular perception that there were no alternatives to equities contributed to pushing the S&P 500 ever higher, reaching a recent valuation peak in September 2020 of 24.1 times the estimated revenue.

Concerns about inflation and the development of interest rate increases have recently provoked unrest in the markets in addition to a heated debate about the correct valuation of shares in the current environment. One source of concern is the risk that the Fed’s tightening will push the economy into a recession, damaging both the business base and investor sentiment. More immediately, higher interest rates reduce the value of companies’ future cash flows in frequently used pricing models.

One concern for financial markets is that bond investors are beginning to expect not only a sharper path for increases, but a higher destination or so-called terminal rate for the Fed. On Tuesday, investors in interest rate futures markets placed an almost 89% probability that the Fed would raise interest rates to around 4% or higher by June 2023. The market-implied probability was 1% four weeks ago, according to CME Group.

In times of need, investors can be quick to decide that stocks are much less valuable. And historically, the valuation has fallen further before the bottom. In the December 2018 sale, during the Fed’s last previous interest rate hike cycle, the S & P 500’s forward multiple fell as low as 13.8. In the depths of sales in March 2020, when the arrival of the Covid-19 pandemic closed parts of the economy, the index traded as low as 13.4 times the expected revenue.

“Markets are not usually close to historical medians,” said Greg Swenson, portfolio manager at Leuthold Group. “They tend to transcend the downside from a valuation perspective.”

Adds Concerns for Stock Investors: Many have begun to worry that corporate profits are coming under threat, suggesting that valuation measures based on earnings forecasts may underestimate how expensive stocks really are. US companies have warned of challenges on several fronts, from rising costs to a currency strike from a stronger dollar.

“These valuation multiples are based on a really overly optimistic earnings outlook,” said Mr. Swenson.

Another valuation model, the Buffett Indicator, compares the value of listed companies in the United States with the country’s gross domestic product. From the end of last week, a version of this target was 29% above the historical average and above the peak in the dot-com bubble days in 2000, which indicates that the market is overvalued. The metric was named after Warren Buffett, who once called the indicator “probably the best single measure of where [stock market] valuations are available at all times. ”

Two recent surveys have shown signs of rising consumer long-term inflation expectations. Fed officials have said they would like to react aggressively to signs that such expectations were rising, or about to be “off the hook”, because they believe the process of turning inflation out of the economy will be far more difficult if it has happened.

These measures are “more consistent with … our own view that a restrictive policy is needed to curb inflation,” wrote Matthew Luzzetti, the US chief economist at Deutsche Bank. “Such a move would also help build the Fed’s credibility that monetary policy is rapidly adapting to a new reality of persistently high inflation.”

Write to Karen Langley at and Nick Timiraos at

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