The robust stock market rally has reversed course in recent weeks, reflecting a significant shift in expectations regarding Federal Reserve interest rate cuts. At the beginning of the year, the market was pricing in six rate cuts for 2024, but that expectation has dropped to one or maybe none at all.

Investors have gone from popping champagne corks to popping antacids.

The CBOE Volatility Index (VIX), known as the “fear gauge,” has spiked above 18. The threshold of 20 or above is considered a bearish sign that stress is taking over.

This growing pessimism has propelled interest rates higher, with the benchmark 30-year U.S. Treasury yield hovering above 4.60%. Sectors sensitive to interest rates, such as small-cap stocks and real estate, have lagged.

The S&P 500 has fallen below its 20- and 50-day moving averages. The next key level of buying support is the 200-day moving average, which would represent a drop of about 6% from current levels. If that level is breached, the rally would be in serious jeopardy.

Keep in mind, though, that market corrections are commonplace, especially following the sort of sharp rally we’ve seen over the past six months.

Here’s a look at the mix of good and bad news and what to expect in the week ahead.

Higher-for-longer rates…

The revision in Fed rate cut expectations stems from unexpectedly hot U.S. inflation readings over the last three months. However, while recent inflation trends have been volatile, certain factors, such as moderating shelter and rent costs, indicate a controlled inflationary environment.

The resurgence of geopolitical tensions, particularly with escalating conflicts involving Israel, has injected fear into markets. Interestingly, crude oil prices have not risen as much as traders had expected, largely due to concerns about decelerating economic growth.

First-quarter earnings season is in full swing. For Q1, with 14% of S&P 500 companies reporting actual results, 74% of companies have reported a positive earnings surprise and 58% have reported a positive revenue surprise, according to FactSet.

While early reports from bellwether U.S. banks exceeded expectations, apprehension looms regarding guidance amid the “higher-for-longer” interest rate environment.

Forthcoming earnings releases from mega-cap technology firms will be pivotal. Strong outlooks from these companies could potentially offset recent market volatility, particularly in tech and other growth-oriented sectors.

In the meantime, stocks have hit a rough patch, as the following table shows:

While market sentiment has soured and indices have dipped, the extent of the pullback remains contained. Valuations had gotten high and a healthy period of consolidation typically follows a sharp rally.

A transition to a deep or prolonged bear market appears unlikely for two major reasons. First, there’s the absence of recessionary conditions in the economy, highlighted by jobs growth and resilient consumer spending. Secondly, the Fed’s cautious approach to rate hikes doesn’t obviate eventual easing. A potential rate cut is still on the table, amid inflation that’s persistent but apparently manageable.

Amid these market fluctuations, you should capitalize on pullbacks by diversifying and deploying dollar-cost averaging strategies, to position your portfolio for a recovery fueled in part by lower interest rates in the foreseeable future.

The week ahead…

Keep a close eye on the following economic reports, scheduled for release in the coming days:

U.S. flash PMIs for manufacturing and services, new home sales (Tuesday); durable goods orders (Wednesday); U.S. gross domestic product, initial jobless claims, pending home sales (Thursday); personal income, personal spending, personal consumption expenditures price index (PCE), and consumer sentiment (Friday).

The most important report this week will be the PCE, an inflation indicator that the Fed monitors closely. If the latest PCE comes in hot, a tipping point for equities could indeed be at hand.

That said, the main U.S. stock market indices bounced back Monday and closed higher as follows:

• DJIA: +0.67%
• S&P 500: +0.87%
• NASDAQ: +1.11%
• Russell 2000: +1.02%

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John Persinos is the editorial director of Investing Daily.

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