Stocktake: Is bad news good for stock markets?

US markets soared last week after the Federal Reserve announced another 0.75 percentage point interest rate hike. The market bounce since mid-June’s nadir has been the longest rally of 2022, raising hopes the bottom is in. Is it?

Yes, say bulls such as JPMorgan’s Marko Kolanovic, who notes stocks have shrugged off weak economic data for weeks now. Kolanovic says a mild recession is priced in and that investors are now lightly exposed to stocks, resulting in markets being less reactive to sombre data. “Bad data is starting to be seen as good”, because increased recession odds also increase the odds of fewer rate hikes.

Kolanovic notes markets are now pricing in a Fed policy reversal, with rates expected to peak earlier (in January 2023, compared to mid-June’s expectation of August 2023) and lower (3.3 per cent, compared to 4 per cent in mid-June). Others are less optimistic. Barclays cautions that while hedge funds have been selling, positioning is “far less depressed” among fund managers and retail investors. It says we have yet to see investor capitulation, with recent equity outflows looking small compared to previous recessions.

Positioning aside, Barclays is sceptical about the idea that a quick, dovish pivot from the Fed will “save the day”, saying more selling remains a threat because the Fed “won’t blink quickly”. That’s echoed by Morgan Stanley, which reckons the Fed won’t stop tightening any time soon. This is the key debate in markets currently. All eyes have been on the Fed’s next move throughout 2022, and that’s likely to remain the case in coming months.