S&P 500's Current Gains Not Justified

The US stock market's rally, which began on March 15th, continues. The S&P 500 index has recovered more than 10% during this period and reached 4610 points - the highest level since January 2022.

Stock indexes have shown steady growth over the past few days, supported by the improvement in market sentiment amid the first signs of progress in the latest round of peace talks between Ukraine and Russia, which ended on Tuesday in Turkey. Market participants were once again hopeful that the parties would find a diplomatic solution and tension would begin to de-escalate as the representative of the Russian delegation confirmed that talks were "constructive." Thanks to this news backdrop, the indices were able to win back most of their losses from the beginning of the year, despite the highest inflation in 40 years, new Covid-19 restrictions in China, and the first interest rate hike by the Federal Reserve System since 2018.

Most economists expect the Fed to hike interest rates aggressively this year to curb inflation, which keeps hitting multi-year highs. This time the US regulator may change its "routine" to raise its key rate in increments of 0.25% and lift its key rate to a target range of 0.5%. Some Fed officials have signaled that they fully support the idea of ​​a more aggressive pace of monetary policy tightening. In addition to the rate adjustment, traders also expect the Fed to start shrinking its near $9 trillion balance sheet inflated during the pandemic. A $3 trillion reduction in the bond portfolio could have the same effect as a series of short-term interest rate hikes.

It is worth noting that the prospect of monetary policy tightening is hardly compatible with the long-term growth of the US stock market since rising rates alongside skyrocketing inflation will negatively affect corporate profits. We recommend considering this, especially if you expect the US stock market to hit fresh record highs. Also, one cannot ignore the current situation in the US Treasury market, which shows all signs of an impending recession. The yield on 10-year Treasury notes has already reached 2.40%, while the yield on 2-year bonds was up to 2.38%. An inverted yield curve occurs when longer-term bonds have a lower yield than short-term debt instruments, and it often indicates the beginning of a protracted economic downturn. With that said, further growth in the S&P 500 seems unlikely, so it's best to look for optimal selling levels. We recommend shorting the S&P 500 if the index drops below 4550 points.