The Fed Could Trigger A Correction

Despite increased volatility and rolling corrections, the S&P 500/SPX (SP500) continues trading near its ATH. The SPX recently nailed a top of around 5,200, which is impressive considering the upside of approximately 27% since the October 2023 correction bottom, which occurred only about four months ago. If we disregard the 2023 correction, the SPX is about 12% above its 2023 high now.

The S&P 500 1-Year Chart

However, bullish momentum is slipping as the RSI and CCI make lower highs. The full stochastic has dipped below 80, suggesting it could soon move toward the 10-20 range. The SPX is also about 13% above its 200-day MA, illustrating that technical conditions remain overextended.

Generally, we appear to be in a healthy bull market, but the SPX and other major averages could correct, enabling a period of more rotation, consolidation, and pullbacks. In my view, we could see one of three scenarios from here:

1. The Best-Case Scenario is a shallow pullback to the 50-day MA, roughly the 5,000-4,950 range, which would result in approximately a 4-5% “correction” in the SPX.

2. The Base-Case Scenario would be a slightly more considerable correction, down to about the 4,800-4,700 support area, resulting in a 7-10% correction.

3. The Worse-Case Scenario would be a relatively deep correction to around the 200-day MA, roughly around the 4,600-4,500 level, approximately a 12-15% decline from the recent high.

The Takeaway

The “worse-case” scenario seems least likely and would probably only occur if the Fed adopted an ultra-hawkish stance, if the prospects of a recession became highly probable, or in another “extreme” case. We could see either the “best-case” or a base-case pullback, resulting in some near-term selling pressure leading to considerable long-term buying opportunities in many high-quality names.

Critical Events This Week

Of course, it’s Fed week. Thus, the Fed interest rate decision and the FOMC press conference are the most critical events. The press conference and the commentary from Fed Chair Powell are especially crucial as market participants will look for clues when the first rate cut may be. It will also be critical to gauge the tone of the commentary as investors will listen for overly hawkish or increasingly dovish notes. I expect the Fed to stick with the markets, walking a fine line. J. Powell probably won’t be too hawkish, but we may see a “sell the news event” if the initial cut expectations continue getting pushed out toward the Fall.

“A No Move” Is Baked In

There is a 99% probability (per the CME Group) that the Fed will keep the benchmark where it is now, 5.25-5.50%. There is only a 1% chance of a 25 Bps cut, and the probability of another rate hike is zero. May will also likely be a non-event meeting, as the likelihood of a rate cut in May is only around 11%.

It’s a different story for June and July, as the probability of a rate cut in June or July is 56% and 76%, respectively. During this week’s FOMC press conference, the market will look for clues of any increase or decrease in rate probabilities, especially for the June/July time frame. Any changes in the Fed’s tone and interest rate probability trajectory could spark market volatility.

Some Earnings to Consider

While there is nothing too substantial on the earnings front this week, several crucial earnings reports are worth considering. First is PDD Holdings Inc. (PDD). Of course, PDD is our favorite Chinese e-commerce giant, with its blockbuster Temu app seemingly taking over the shopping world. I recently ordered some cheap stuff for the kids and the car from Temu, and it’s remarkable how easy and seamless the shopping process was.

PDD’s earnings are scheduled for early morning Wednesday, and PDD could beat again. Some concerns have been raised regarding “forced labor” and Temu. However, this appears politically motivated, and if there are concerns about Temu, then there should be concerns about all companies operating in China, in my view. For instance, about 80% of all Nike shoes are still made in China, but I don’t see Congress raising concerns about them.

Micron Technology, Inc. (MU) will report earnings after the bell on Wednesday. We saw a constructive announcement last month, and more progress should be met with optimism. However, on the other side of the equation, MU has shown inconsistency before. Therefore, we must be on the lookout for that. NIKE, Inc. (NKE), FedEx Corporation (FDX), Lululemon Athletica Inc. (LULU), and Darden Restaurants, Inc. (DRI) are also interesting, as they should provide insight into the overall well-being of the economy and the health of the consumer.

The Bottom Line

Markets tend to get volatile around Fed events, and this week may be no exception. Also, the market is around ATHs. Therefore, any rhetoric that the market perceives as unfavorable could exacerbate selling pressure, leading to increased volatility and enabling the highly anticipated “correction” or pullback to take place.

I suspect that the 5,200 level in the SPX may be a near-term high, and a best/base case correction could occur. Therefore, we may see the SPX pull back to about the 5,000-4,700 region before the dip is bought aggressively again.

However, I view the possible correction as a constructive phenomenon that should create substantial buy interest in some of our favorite high-quality stocks. Also, despite the possibility of increased near-term volatility, my year-end target range remains 5,700-6,000 for the SPX.

Several Stocks On My Buy List As The Market Pulls Back

Broadcom Inc. (AVGO), QUALCOMM Incorporated (QCOM), Meta Platforms, Inc. (META), and other high-quality stocks with AI exposure. I would also like to increase Tesla, Inc. (TSLA), Amazon.com, Inc. (AMZN), Advanced Micro Devices, Inc. (AMD), NVIDIA Corporation (NVDA), and Alphabet Inc. (GOOG) (GOOGL) on further weakness/more considerable pullbacks in future weeks.