Major U.S. equity indices were down over 3.5% for the week as investors grumbled over increasing odds of a Federal Reserve rate hike. Readers may recall the now-infamous “taper tantrum” response to Fed talk of slowing down the rate of bond purchases two years ago. With markets having become overly dependent on at least the perception that Fed actions support prices on the way up, we should not be surprised that the same markets might react negatively at the prospect of Fed rate hikes as well, at least in the short run.
In contrast to short-term kneejerk market reactions, the intermediate to longer term response is more critical for investors. Since rate hikes telegraph Fed confidence in current and future economic growth, historically markets come around to more positive sentiment eventually. Generally, the party continues until the Fed removes the punch bowl, most often overshooting the mark with rate hikes that cause recessions. We are certainly nowhere near that point at the moment.
Risk aversion was evident across the board for the week. While the large cap Dow Jones Industrial Average and the S&P 500 were down 3.64% and 3.56% respectively, their smaller brethren fared even worse. The S&P Midcap index was down 3.87%, the S&P Smallcap 4.55%, and the Russell 2000 lost 4.4%. The tech-heavy NASDAQ Composite was down 4.22%.
Fed funds futures are now pricing in a 64% chance of a December rate hike, up from around 50% at the start of the month. In addition, and in a distinct departure from prevailing conventional wisdom, market expectations have begun to price several rate hikes into 2016, as conviction about economic and job growth and higher rates gains more clarity.
Quarterly earnings season is winding down, with a late rush of retail stores announcing disappointing results and further weighing on investor sentiment. Traditional brick-and-mortar stalwarts Macy’s (-14%), Nordstrom (-15%), and J.C. Penney (-15%) all reported revenue and profit misses and were punished accordingly. Online retailer Priceline was not immune, falling nearly 10% and blaming the strong dollar and a drop in U.S. bookings for disappointing profit forecasts.