The Rate Cut Has Already Been Priced Into the Market

Just one more day until the Fed cuts short-term rates by 25 basis points.

The major stock averages have been rallying in anticipation of that event. Technology, semiconductors, AI stocks, financials, homebuilders, and just about every sector that benefits from lower rates have moved higher on the expectation of lower rates.

From a contrarian perspective, it’s easy to make a case for a “sell on the news” event. The market has already priced in a rate cut.

But, it also seems like everyone sees the potential for a sell-on-the-news decline. So, maybe, it doesn’t happen right away…?

Instead, maybe we get a “blow out the shorts” rally first, then a reversal to sell on the news…?

Or, maybe I’m overthinking it.

The bottom line for me is… Much of the benefit of a rate-cutting cycle has already been priced into the stock market. There’s just no other way to justify the S&P 500 trading for 24 times forward earnings. So, the upside from here sure seems limited to whatever short-covering can be forced to happen following Wednesday’s FOMC announcement.

On the downside, though… there sure seems to be a lot of potential for a larger move.

The entire rally from mid-May, with the S&P near 6000, has occurred with negative divergence. It has happened on weak breadth – with more stocks trading lower than higher. And, it has happened as economic indicators have pointed more towards a period of stagflation than a period of expansion.

Yet, the momentum has been clearly bullish. Fighting it has led to poor results.

So, come Wednesday, the real question is… “Is there enough momentum left to kick off a new rally phase, and push the market even higher into record valuation levels?”

It’s hard to see that happening. Then again, it was hard for me to see the S&P get anywhere close to 6600 this year too.

But, with investor sentiment (a contrary indicator) at high bullish levels, and institutional cash positions at record low levels, it’s difficult to decipher what is going to fuel a big market rally.

So, I have to lean bearish – or at least strongly cautious.

I don’t want to. It is much easier, after all, to be bullish – to root for higher stock prices, and to dance with everyone else at the party.

Throughout history, though, buying the S&P 500 at 20+ times forward earnings, and when the Buffett Indicator (market capitalization divided by GDP) is at new highs, has led to rather poor intermediate-term returns.

That doesn’t mean there isn’t anything to buy. Many stocks are still trading near their April lows. Many stocks haven’t participated at all in the recent melt-up rally. And, as money comes out of the high-flying names it will likely flow into some of these bargain-priced stocks.

We just need some sort of catalyst for that to happen.

It’s hard to imagine a more appropriate catalyst than a “sell on the news” broad market decline following the FOMC announcement tomorrow.

Best regards and good trading,

Jeff Clark
Editor, Market Minute