Why Stocks Will “Top Out” in July

Stocks ticked modestly higher this morning in anticipation of a rate hike “skip.” The Dow took a slight dip, falling by 106 points (-0.3%) as investors held their breath for the Federal Reserve’s policy decision and the follow-up press conference scheduled for later today.

Meanwhile, the S&P 500 edged up by 0.3% and the Nasdaq did slightly better, increasing by 0.4%. UnitedHealth, however, took a hit and ended up being the biggest burden on the Dow, with a loss of 7% after the company warned of a dramatic change coming to the health insurance industry.

UnitedHealth CFO John Rex said that a former pileup of elective medical procedures has been unleashed on hospitals in the US. This should drive up insurance costs substantially as demand outstrips the number of available doctors.

Apart from waiting on the Fed’s policy news and sweating over a health insurance selloff, investors are also looking forward to hearing from Fed Chairman Jerome Powell in his post-meeting press conference. Bulls are hoping for an “economy stubbornly strong, wait and see on rates” message.

In all likelihood, though, Powell will be back with another rate hike in July even if he skips one this afternoon.

The producer price index (PPI) for May hinted at a pause this morning after it showed a month-over-month (MoM) decline of 0.3%. This decrease is bigger than what economists predicted (-0.1% MoM). After yesterday’s consumer price index (CPI) report showing the smallest yearly increase in more than two years, investors are feeling a little more optimistic that the Fed might hold off on raising interest rates.

“With things being pretty calm and the Fed seeming ready to take a break, I’m really interested to see where the market will go after today’s announcement,” said Joseph Cusick, head strategist at Calamos Investments.

“However, if people are still making moves based on hype and fear, it makes sense that the ongoing trade – or the ‘pain trade’ as some call it – will go up.”

According to CME Group’s FedWatch tool, there’s a 97% chance that the Fed will keep interest rates where they are. That would break the Fed’s streak of 10 straight hikes.

This positive outlook gave the market a boost on Tuesday. The Dow added almost 146 points, a 0.4% increase, while the S&P 500 and Nasdaq rose 0.7% and 0.8%, respectively. Both the S&P 500 and Nasdaq reached their highest levels since last April during Tuesday’s session.

Historically speaking, pauses in hiking cycles have been good for stocks. The S&P rose 5% on average in the three months following a hike pause over the last 30 years. Over the next 12 months following a pause, the index rose 16% on average.

And though that might seem like great news for bulls, it’s also a bit misleading. The issue is that when the Fed pauses, it’s usually only a few months until a recession hits and the rate cuts begin. The cutting, not the pausing, has been the big driver for bull markets since 2000.

A pause today would probably not represent an end to the current hiking cycle. July is likely the last hike for the year.  What’s more, inflation should remain well above the Fed’s target, which means that cuts may not arrive as quickly as they normally would following a pause.

Investors need to temper their long-term market expectations because of this, even if stocks do run higher into July when the final rate increase hits.


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