When the market gets sick, analysts look for cures. For now, they've settled on an interest rate hike by the
Uncertainty about future rate hikes and concerns that the Fed is behind the curve on inflation have sent stocks swooning over the past week. On Monday, the
Dow Jones Industrial Average
fell below 10,000 and the
broke below 1900 for the first time since March.
Analysts say investors are worried about the timing and magnitude of a rate hike and would feel a whole lot better if the Fed just went ahead and got it over with.
"I believe that the stock market might have rallied if Fed officials started showing more action and talked less," said Ed Yardeni, chief investment strategist at Prudential Securities. "I believe that the stock market will perform better once the Fed starts raising rates, which could now occur at the June meeting."
That's not to say the market couldn't see some kind of relief rally in the interim, of course. Several analysts believe that stocks have become very oversold recently.
Jason Goepfert of SentimenTrader.com, noted that over 20% of stocks trading on the NYSE made new 52-week lows Friday. Over the last 20 years, this has often presaged a big rally in the market. In fact, he said, the average gain over the ensuing 90 and 120 days has been 16.8% and 19.2%, respectively.
Still, other market watchers say it will be hard for stocks to mount this kind of rally until the Fed pulls the trigger. Historically, the market has fared poorly in the runup to a rate hike but has improved once rates started to rise, according to Merrill Lynch.
So does the market need a rate hike to pull it of its recent funk? Well, that's debatable.
Jeffrey Saut, chief investment strategist at Raymond James, said a rate hike could actually squeeze more air out of the stock market. "Maybe the markets have fully discounted a rise in rates, but it is always possible that the event will lead to more unwinding," he said.
Quoting Pimco bond guru Bill Gross, Saut noted that the U.S. has transitioned to a finance-based economy and that many banks and nonbank financial companies now dominate the economy. Manufacturing firms of 30 years ago, like
, are now in the finance business and the cost of capital is key to their profitability.
A rate hike could seriously hurt many of these firms, particularly since they are so heavily leveraged, Saut argued. "The pain of returning to a more normal relationship between interest rates and inflation in a heavily leveraged economy could be a perilous one," he said.
Other analysts say a rate hike would reduce consumer spending, which has fueled economic growth over the past few years. Already, there have been signs that consumer spending might be slowing down as oil prices surge, and it could weaken further in the second half of the year when the effects of tax rebates and refinancing wears off. Since consumer balance sheets are in such disrepair and wage growth remains so sluggish, a rate hike could have serious consequences, some pundits warn.
If the Fed were to raise rates in June, worries over monetary policy aren't going to disappear, bears argue. After all, Fed funds futures are pricing in over 100 basis points of tightening this year. Meanwhile, concerns about a slowdown in economic growth or profits and uncertainty about the geopolitical situation could continue to plague the market.
The U.S. is expected to hand over sovereignty to Iraq at the end of June. If that doesn't happen, or fresh violence erupts in the region, investors could become increasingly nervous about holding stocks.
To be sure, a rate hike would go a long way in satiating the bond vigilantes and those who feel the Fed is behind the curve. Whether it's a panacea for stock investors is a far harder question.