Lower Earnings, Lower Rates and Lower Multiples

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If the Federal Reserve does not cut its target for the federal funds rate by at least 25 basis points at the end of this month, many in the market will feel entitled to sue the central bank for breach of contract. Wednesday’s congressional testimony by Fed Chairman Jerome Powell and the publication of the minutes to the central bank’s last monetary policy meeting were the last chance to walk back the widespread assumption that a July rate cut is a certainty. Powell made no attempt whatever to do so.

The market odds of a rate cut of some dimension are now 100%, and there is no precedent for the Fed bucking a market expectation that is this clear-cut this close to a policy meeting. We can assume that the Fed is in easing mode. In response, bond yields remain low and the benchmark S&P 500 Index of equities briefly topped 3,000 for the first time on Wednesday.

This is strange because investment managers have lapsed into a bearishness and pessimism that have not been seen since the financial crisis. That was the conclusion of the latest Bank of America Merrill Lynch monthly survey of fund managers, while Absolute Strategy Research’s Multi-Asset Survey, which polls fund managers on their perceived probabilities of different outcomes, also suggests that investors are worried. Indeed, their predictions imply terrible problems for equities ahead. Only a minority believes that corporate earnings will rise over the next year, the most bearish outcome since the survey started: