Why equity investors might have expected too much

After a challenging first half to 2022, equity investors received a much-needed hit of hope as stocks rallied early in the summer. But as that energy has stalled over the past few weeks, market participants would do well to consider that we may not be out of the woods yet.

That’s according to Kevin McCreadie, CEO and Chief Investment Officer at AGF Investments, in a recent commentary.

“The big question facing all of us is whether the run up in stocks over the past two months marks the beginning of a new bull market or a temporary reprieve in a bear market that still has legs,” McCreadie said.

While the outlook remains cloudy, he said the direction of stocks and bonds will likely continue to be more influenced by American policy and other central banks than any other catalyst or risk at the moment.

Due to a belief that inflation has peaked and painful rate hikes won’t be as necessary moving forward, many investors have concluded that U.S. equity markets have bottomed. Until recently, some believed that the size of future rate increases in the United States would gradually taper in the coming months, with 50-basis point hikes in September and November and a 25-basis point increase in December, and reductions sometime in 2023.

“But that is not how it likely unfolds from here. To the contrary, it’s looking more like another 75 basis-point rate hike may be in the cards,” McCreadie said, pointing to a speech by Federal Reserve Chairman Jerome Powell after the recent Jackson Hole Economic Policy Symposium. In that speech, Powell said rates will continue going higher until inflation gets under control.

Given that declaration, McCreadie said, the likelihood of a recession can’t be discounted, and equity markets can’t be expected to rally further just because the preceding selloff had fully priced in a recessionary scenario. While stock markets are usually reliable leading indicators for the larger economy, he said investors should not discount the possibility that recent lows will be re-tested based on the language from the Fed.

In the coming weeks, investors should anticipate two key announcements: U.S. inflation data for August, and the Federal Reserve’s next rate announcement. The period between those dates could bring greater-than-normal volatility, McCreadie said, as market participants re-adjust their Fed expectations.

“Beyond that, growth and employment figures need to be analyzed perhaps more than usual over the next few months,” he said. “Either way, it could be another grind for equity investors this fall.”