Federal Reserve’s message to the bullish stock market: We will break you

This is The Takeaway from today’s Morning Brief, which you can sign up to receive in your inbox every morning along with:

Not watching stocks tick by tick sometimes has its benefits.

That’s where I am at right now after spending a week in sunny Cannes, France, with my Yahoo colleagues covering the Cannes Lions.

We laughed, we didn’t cry, we talked to big names such as Kevin Hart and Pinterest CEO Bill Ready about business matters and we ate incredibly fresh food that oddly didn’t seem too inflationary. I even tried to dance at a late-night party (it was for business, people).

One thing we didn’t do was pay attention to stocks every waking second. It felt as refreshing as the ocean water I let touch my calves during a 15-minute break after we wrapped taping on Thursday. At least for me, that market detox has proven incredibly helpful as I get back to reality in increasingly warm New York City.

My blunt view on markets: The Fed is trying to club the bulls over the head to remind them who is boss. It may be wise for those bulls that have made bank on AI stocks, tech names like Microsoft, and of course Tesla, to respect the mighty club of the Fed and pull in their horns for a bit.

Sentiment has shifted on Wall Street to begin the summer, thanks in large part to new information from the Fed. The Fed’s pause on raising interest rates a few weeks ago has spooked investors as it’s clear a pause doesn’t mean no more rate increases. Powell’s testimony last week added further fuel to the view that two more rate hikes are coming this year to wrangle inflation, perhaps much to the detriment of the economy.

I expect a similar hawkish tone to emerge from Powell’s two speeches later this week.

“One of the big stories this year is that central banks continue to surprise the markets with either more rate hikes or hints of more to come,” proclaimed Bank of America economist Ethan Harris.

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Harris is on the mark with that observation and is right in questioning the markets’ resilience amid those negative surprises.

“Markets have also proved remarkably resilient with only a mild tightening of financial conditions. Despite the rapid game of catch-up by central banks in the past year, there have been very few financial ‘accidents.’ The one potentially serious shock — the stress in US regional banks — seems to have been ring-fenced with very aggressive actions from regulators. It is striking how strong global equity markets are relative to their pre-COVID levels,” Harris added.

Widely respected Goldman Sachs strategist David Kostin has also laid the groundwork for more near-term pressure on markets as investors stew on Fed confusion.

“While our baseline view remains that the S&P 500 will rise by 3% to 4500 by year-end, the narrow market rally, elevated valuations, and stretched investor positioning represent downside risks,” Kostin wrote in a weekend note.

Continued Kostin, “If corralling inflation requires the Fed to implement additional hikes to the policy rate, stocks with ‘quality’ attributes like strong balance sheets, low volatility, and high returns on capital should outperform.”

That’s a counter vibe to the risk-taking bullishness that sent markets to records just a few weeks back and the likes of Nvidia to a $1 trillion market cap.

Fight the Fed at your own risk…but let it be known I didn’t fight the currents on the beach in France. I went back to my towel to soak in some sun — which was the correct move.

Brian Sozzi is Yahoo Finance’s Executive Editor. Follow Sozzi on Twitter @BrianSozzi and on LinkedIn. Tips on the banking crisis? Email [email protected]

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