The S&P 500 story points to a sharp jump after the Fed meeting

(Bloomberg) — For stock investors in the dark, an interest rate hike expected from the Federal Reserve on Wednesday may actually bring some relief.

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US stock markets are feeling the heat ahead of the Fed meeting, with the S&P 500 and Nasdaq 100 down 6.2% and 7% respectively over the past six days, on an outside chance that Chairman Jerome Powell will take an even tougher stance to combat the scorching inflation.

Still, if history is any guide, markets may be due for a bounce once the meeting is over and done with.

Over the past 18 months, the S&P 500 has risen after eight out of 10 Fed decisions. In the days after the Fed meetings in January, March and June, stocks rose between 6% and 9% after falling sharply early on.

“Expectations are very hawkish and the Fed could come out exactly as expected and still be more dovish than expected,” Brad McMillan, chief investment officer at Commonwealth Financial Network, said in emailed comments. “That probably limits the market’s downside from this meeting and just might provide some upside going forward.”

Wednesday is expected to bring the Fed’s fifth straight rate hike this year, with borrowing costs rising to 3.25%. That pushed the 10-year bond yield above 3.5%, the highest since 2011, forcing many investors to dump stocks.

But extreme bearishness can also prove to be a source of support for stocks. Fund managers are the lowest-weighted stocks they’ve ever been, while cash levels are at an all-time high, according to Bank of America Corp.’s latest monthly survey.

S&P 500 futures gained 0.3 percent by 7:04 a.m. in New York, while Nasdaq 100 contracts were little changed.

“There has been so much speculation about the Fed’s next move that finally a decision should provide much-needed relief for investors,” said Danny Hewson, financial analyst at AJ Bell. “If it sticks to the script and delivers another 75 basis point hike, markets are likely to rally somewhat, in part because the specter of a full rate hike hasn’t happened.”

Another gauge, the CFTC’s net non-traded S&P 500 futures, is also showing an extremely negative outlook, having reached levels last seen during the downturns of 2008, 2011, 2015 and 2020. Such gloomy sentiment is often seen as adversarial indicator marking a recovery.

“Stable earnings, low investor positioning and well-established long-term inflation expectations should moderate any decline in risk assets from here,” JPMorgan Chase & Co. strategists led by Marko Kolanovic said in a note on Monday.

Market technical data may also signal that a bottom is near, especially for technology stocks. The tech Nasdaq 100 is down 27% this year, and about 16% of its constituents are currently trading just above their 200-day moving average.

Analysis shows that this kind of reduced technical breadth coincides with previous market bottoms – with the exception of 2008.

Not everyone is convinced that a rally is imminent. U.S. stock valuations remain elevated relative to history and past economic downturns, keeping some investors wary of increasing exposure as the Fed continues to raise interest rates.

“We expect excessive policy tightening that causes recessions,” said Wei Li, global chief investment strategist at BlackRock Inc. in a note on Monday. It has a tactical underweight position on the stock because “recession risks have not yet been factored in.”

According to Nomura quantitative analyst Yoshitaka Suda, supply and demand dynamics among speculative investors are setting up US stocks for more softness, with macro funds building short positions immediately after the latest US inflation data. Macro funds “will remain short U.S. stocks at least until the release of employment data” on Oct. 7, Suda said in a note.

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