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Are investors disregarding the warning from the Federal Reserve?

Last week’s market decline could be attributed to mounting evidence that the Federal Reserve will continue to raise interest rates this year.

All three major indices ended the week down, with the S&P 500 down 1.4%, the Dow Jones Industrial Average down 1.7%, and the Nasdaq Composite down 1.4%. The S&P 500’s bull market status and the price of mega-cap technology firms reaching all-time highs were abruptly halted when all three major indexes ended their winning streaks of weeks.

What caused last week’s declines? In testimony before congressional lawmakers on Wednesday and Thursday, Federal Reserve Chair Jerome Powell reaffirmed the central bank’s commitment to reducing inflation to 2% and indicated that rates will likely be raised twice more this year.

Futures traders presently price in only one more rate hike this year, indicating that investors do not expect that two more raises are likely.

Investors had been expecting a rate hike of only 0.25 percentage points, so the Bank of England’s 0.5 percentage point increase came as a surprise.

Despite the Fed’s hawkish signalling, the BoE’s hike, and last week’s losses, Wall Street is showing no signs of fear. The Cboe Volatility Index (VIX) is a measure of expected volatility that is calculated from the prices of options on the S&P 500 index. The fear index on Wall Street dropped to 13.44 last week.

Even while the market as a whole was falling, mega-cap technology stocks nevertheless managed to post significant gains. On Thursday, Apple stock reached a new high of $187 at market close.

Are investors indifferent to the Fed? Certainly not! Tom Graff, head of investments at Facet Wealth, an investment advising firm, says that investors’ views on inflation differ from the Fed’s for simple reasons. In other words, investors anticipate that inflation will decrease even if they believe the Fed might hike rates twice more if necessary.

Recent measures of inflation corroborate this forecast: According to data from the Consumer Price Index for May, yearly inflation slowed to its lowest level since March 2021. The May PPI data also revealed that wholesale inflation has decreased to below its pre-pandemic average.

No longer do people worry that the Federal Reserve will “hike us to oblivion,” as Graff put it.

The Federal Reserve may be hinting at further rate hikes to give itself some leeway while attempting to calm the market. He argues that investors would be less concerned if the Fed signalled additional rate hikes were coming and then didn’t follow through than if the Fed had predicted cuts or a pause and then hiked instead.

Was last week’s drop a fluke or the beginning of a trend? Forget about asking how much something costs. However, the movement of stocks, in whichever direction that may be, is unlikely to be a straight line.

The market seems to be showing signals of a possible upward trend. This year’s surge has been spearheaded by large-cap technology stocks like Nvidia and Microsoft, but in recent weeks it has spread to other asset classes, including previously struggling small-cap equities.

A widely followed technical gauge of market breadth shows that more S&P 500 equities are trading above their 200-day moving averages than ever before.

However, more than 60% of S&P 500 equities are trading above this trendline, “when 80-90% of constituents typically trade above their 200-day moving average for the majority of the first year following a major market bottom, it is not quite enough to be convinced of a new bull market,” so wrote SoFi’s director of investment strategy, Liz Young.

Gina Bolvin, president of Bolvin Wealth Management Group, says the next earnings season will be the next test for equities. This is especially true given that profit results that have come in stronger than predicted so far this year have helped fuel the market boom.

This market can and should rise if we return to fundamentals, she remarked.

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