Why Is the Stock Market Down? It Knows the Worst Is Yet to Come.

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After a certain point, there is no turning back. The stock market reached this point last week.

Oh, the market was hoping, going into the week, that inflation had peaked, that the Federal Reserve would stop raising rates soon, that the fund was ready. But Tuesday’s release of consumer price index data for August showed that inflation had… It hasn’t been tamed and wiped out all the goodwill, sending the major indexes to their worst day since 2020

Then

FedEx

(Ticker: FDX ) decided to tell investors, a week early, mind you, that its earnings were terrible and that it was withdrawing its full-year guidance. All of this happened the week before the Fed meets to discuss its next rate hike, which is likely to be another 0.75 percentage points.

You can’t avoid what’s coming now, and the stock market knows it. The

Dow Jones Industrial Average
fell 4.1% during the week, while the

S&P 500
the index fell by 4.8% and the

Nasdaq Composite
fell 5.5%.

“Investors are facing the reality that the Fed has more work to do and the risk of a recession is high,” said Dave Donabedian, chief investment officer at CIBC Private Wealth US. “We are not talking about putting more money to work in the equity markets. We are preaching patience.”

This seems to go against the maxim that it often pays to be optimistic when everyone is predicting the worst. Sundial Capital Research’s Jason Goepfert notes that fewer than 1% of S&P 500 stocks ended higher on Tuesday, which has happened only 28 other times since 1940. The index gained an average of 15 .6% over the following 12 months, and was higher 79% of the time.

So is this a buying opportunity?

Not too fast. At times, the market can become “oversold,” notes Doug Ramsey, chief investment officer at the Leuthold Group. This may be the prelude to further declines, as was the case in 1998, before the collapse of long-term capital management; in 1987, before Black Monday; and ahead of the worst bear market sales of 1973-74. “Excessively oversold conditions have preceded most of the worst short-term market collapses,” explains Ramsey.

The odds of one increase. The Fed seems determined to keep inflation in check, and that could mean rates are going up a lot. Where investors once worried about a terminal rate of 3.5%, now they are talking about more than 4%, or even 5%. And once the Fed gets there, it’s likely to stay there rather than start cutting rates right away.

However, bear markets typically don’t end, and bull markets don’t begin, until the Fed begins to ease, according to Ed Clissold, chief U.S. strategist at Ned Davis Research, and sometimes not until after the second rate cut. When a bear market has ended before the Fed has finished raising rates, a second bear market usually occurs. “History argues that the tightening cycle will cause more pain in the stock market,” Clissold writes.

Even if this turns out to be wrong, now is not the time to be a hero. Nordea Asset Management strategist Sebastien Galy notes that investors should try to identify companies that are “attractive solutions with less downside risk and that are resilient to a multiplicity of scenarios and styles,” a long way to say quality actions. “What we can struggle with is managing these complex risks and starting to position ourselves over the coming quarters at the right valuation,” he concludes.

Or just wait it out.

Write to Ben Levisohn at Ben.Levisohn@barrons.com