Where is the S&P 500 Going From Here?

The S&P 500 (ASX: SPY) has been selling off since it peaked at its all-time high of $479.98 on Jan. 3, 2022. Shares fell as low as $410.64 before staging a bounce attempt. Since the pandemic lows of $218.26 set in March 2020, the "buy the dip" strategy has worked out well for the most part. However, there is a key reason it's no longer working and may not work moving forward, higher interest rates. The U.S. Federal Reserve has been incredibly dovish with its quantitative easing (QE) pumping over $120 billion a month in asset purchases ballooning the balance sheet to nearly $9 trillion. The "easy" money has been a boon to investors, and a bane to savers as interest rates literally non-existent and a bane to consumers as this has allowed inflation to spike to the highest levels in 40-years at 7.5%. This is a far cry from the 2% inflation rate that the Fed has targeted. The question is why has the Fed let inflation rise so high?

Transitory or Sustained?

Due to the COVID-19 pandemic and self-inflicted economic stops from lockdowns, the drop in productivity was expected to be temporary. On the flipside, the snap-back recovery bounce on the reopening was also expected to be temporary as it overshoots. Replace the word temporary with the term transitory and that's what Fed Chairman Jerome Powell was preaching all through 2021. The inflationary pressures are due to the spike in demand overwhelming the supply shortage as a result of the reopening from the pandemic. It's all temporary and will revert back to "normal", right? However, the problem is that shutting down factories and production and then getting them back online is not an easy or cheap task. This is evident by the global chip shortage and supply chain disruptions we're seeing globally. Food, fuel, and wage inflation has run amok as the U.S. has seen the fastest spike in CPI in four decades. The Fed has changed its rhetoric and eliminated the word "transitory" from its vocabulary. Since unemployment is at record lows under 4%, the "coast is clear" to start monetary tightening gradually.

Monetary Tightening

We have been in a monetary expansion period since the pandemic. Now it's time to pay the piper (back). This means tapering down the monthly bond purchasing (QE) program and nearly eliminating it in Q1 2022. It also means trimming the massive Fed balance sheet down from nearly $9 trillion. Most impactfully, it means raising interest rates to combat inflationary pressures. The combination of all three drive the monetary tightening process designed to dampen the pace of economic expansion and inflationary pressures. Naturally, this is bearish for asset prices especially stocks. The stock market moves on rumor and resolves on news. The anticipation of rising rates and transition to a hawkish stance was evidenced by the December FOMC meeting minutes. This set-off the stock market cliff dive in early January 2022 as the SPY fell nearly 10% off its highs and Nasdaq fell 20% off its highs by the end of February, before the recent bounce. There is wide speculation that the Fed will raise interest rates from 3 times up to 6 or 7 times as Jamie Dimon of JPMorgan Chase commented on its earnings conference call. The bottom line is higher interest rates mean lower markets as "risk off" stance takes effect. The Russian invasion of Ukraine is causing oil prices to spike and the ensuing sanctions against Russia will impact prices for products in the U.S. and globally. While some speculate that the Fed may ease up on the hawkishness due to the geopolitical events, if the outcome is the acceleration of inflationary pressures, then the Fed will have to react even harder to offset the expectant surge. This year may very well be one of playing defense as the whole market climate has reversed with the Federal Reserve's stance on interest rates. There will be opportunities for investors and traders who administer discipline and patience over panic and FOMO. Let's take a look at where the most opportunistic spots will be on the SPY.