- The Stock Market Is a Forecasting Machine
- Today's Market Context
- A Longer-Term View
- Beware Volatility
The Stock Market Is a Forecasting Machine
Markets expect the Federal Reserve to announce an interest rate cut next week. In anticipation, major indices have climbed on the idea that cheaper borrowing costs will extend the economic expansion. As I discussed recently, rate cuts do indeed bolster the financial system.
But we should remember the stock market is a forecasting machine. Equity markets look ahead, and when traders are convinced the Fed will cut rates, they reposition weeks in advance. By the time the decision arrives, the buying power has been used up.
Moreover, reality can disappoint. If the Fed announcement doesn’t deliver sufficient easing as hoped for (perhaps emphasising inflation risks), enthusiasm will quickly cool..
And even if the Fed does deliver, short-term traders may decide to capture gains – exiting to take profits when the event is confirmed.
All these factors lie behind the common phrase: “Buy the rumour, sell the news” - which JP Morgan referred to in a note yesterday, echoed by other banks.
Once an outcome is all but certain, stock prices have already “baked in” the news.
Today’s Market Context
This dynamic is especially relevant today. The equity rally has been highky concentrated in a handful of mega-cap technology stocks. The “Magnificent Seven” have powered indices higher: markets are more fragile than they appear.
27th January is a good reminder – in one day, Nvidia plunged 17% - wiping out $600 billion of market capitalisation. Momentum can quickly reverse at any time.
A Longer-Term View
“Sell the news” episodes are part of the rhythm of short-term trading. However, over the longer horizon, the impact of rate cuts lies in how they shape growth, earnings, and household balance sheets over months and years.
What's important is how monetary policy influences the economic backdrop over time. Any the economy moves a lot slower than markets.
Beware Volatility
With the S&P 500 at record highs, investors must consider how much of the upcoming rate cut is already baked into today’s prices.
As September 17th approaches, volatility is likely. The Fed may well cut rates, but that doesn’t guarantee a fresh rally. Much of the good news may already be priced in, and a “sell the news” response wouldn’t be unusual.
