Long term bulls on Wall Street and the president of investment consulting firm Yardeni Research, Ed Yardeni, recently warned that the risk of the Federal Reserve triggering a stock market crash in the United States is increasing.
In his latest report, he explained that Federal Reserve Chairman Powell stated last month that the next interest rate decision is likely to be a rate cut, not a rate hike, so the Federal Reserve put option has returned to the market.
"Investors expect the Federal Reserve to nip recession in the bud through loose policies, which means the Fed's put options are back. It does indeed reduce the risk of economic recession and bear markets. But it increases the risk of stock market crashes," he wrote.
The so-called Federal Reserve put options actually refer to Powell's strategy of selling S&P 500 index put options, which is equivalent to setting a bottom price protection for risky assets. To achieve such protection, the Federal Reserve will convey a dovish future policy guidance signal: once the economy shows signs of weakness, they are prepared to actively relax monetary policy; At the same time, they do not intend to tighten monetary policy when economic growth or inflation rebounds.
In this situation, investors' expectation that the Federal Reserve will cut interest rates to prevent potential recession (whether realized or not) may release a new wave of faith, driving the stock market up significantly from its current level.
Yadini himself believes that the S&P 500 index will reach a historic high of 5400 points by the end of this year, and he also stated that the index may soar by 25% to reach 6500 points by 2026.
"We do not expect a recession that the Federal Reserve will have to cope with through loose monetary policy this year. However, due to some investors' belief that this could happen, the Federal Reserve's put options have returned. As a result, the risk of a stock market crash continues to increase," he added.
Unsustainable stock market prosperity
After the first quarter performance of the US stock market was better than expected, profit expectations continued to rise, which made Adeni more optimistic about the outlook for the US stock market. But at the same time, he is also more concerned about the potential risks of unsustainable prosperity in the US stock market.
Wall Street analysts currently predict that the profit growth of S&P 500 companies this year will be 10.1%, accelerating to 13.9% and 11.8% in 2025 and 2026, respectively, indicating an increasingly optimistic profit outlook for the company.
Yadini explained, "As we have often observed in the past, if the likelihood of an economic recession is low, then the profit expectations of the S&P 500 index are a very good leading indicator of actual profit outcomes. In the long run, growing profits will ultimately drive stock prices higher."
"But the risk of stock market surge increases simultaneously with the risk of stock market selling, because stock market surge is rarely sustainable and usually leads to rapid and painful declines," he said.
The term "melt up" was coined by Yadini in a blog post in 2016. It means that due to investors not wanting to miss the opportunity to make money from the stock market's rise, they start to flock to buy, leading to a sudden and sustained rise in asset prices, rather than an improvement in fundamentals. This has led to an increasing number of bulls in the market, with super optimistic sentiment and a continuous upward trend, even accelerating the rise.