Lewis Krauskopf, SaqibIqbal Ahmed

NEW YORK, (Reuters) – Stock market investors look particularly pessimistic as they await the U.S. Federal Reserve rate-setting announcement. There are new milestones in bond yields and concerns about rocketing inflation that will weigh on sentiment. The central bank is likely to raise rates even further.

This year, the benchmark has dropped more than 12 percent after suffering its largest monthly fall since the outbreak of the pandemic. On Monday, the U.S. Treasury yield hit 3%, its highest level in three years. This is a double increase since the beginning of 2021.

According to Sameer Samaa, senior global strategist, the higher yields of U.S. government bonds are almost risk-free and you may be losing some investors who have moved into dividend-paying stock. Wells Fargo Investment Institute.

“The implication for equities is you start to lose demand for stocks relative to fixed income,” Samana said.

Some investors appear very disillusioned. Paul Tudor Jones is the founder and chief executive officer at Tudor Investment Corp. He stated on Tuesday that there was no better environment for investors than what he sees right now.

Yields up, stocks down https://fingfx.thomsonreuters.com/gfx/mkt/akpezyjjqvr/Pasted%20image%201651594541397.png

In another measure of stocks, the 10-year Treasury Inflation Protected Securities yields (TIPS) have surged to positive territory. They were previously in negative territory from March 2020.

Investors who have bought 10-year Treasury notes with negative real yields would have experienced an annualized loss of money. Inflation adjusted, this dynamic helps to diversify money away from U.S. Government bonds and towards stocks and other more risky assets.

Real U.S. yields on the rise https://graphics.reuters.com/USA-STOCKS/FED/zjvqkmdkzvx/chart.png

Cboe volatility, also known as Wall Street’s fear gauge, has seen a rise from 20 just weeks ago, to more than 36 Monday, and just shy of 30 Tuesday. A higher reflects investor expectation for more volatile markets in the short term.

Rising risk https://fingfx.thomsonreuters.com/gfx/mkt/mopanobdava/Pasted%20image%201651593560098.png

Stock investors feel pessimistic as they watch the market slide. The American Association of Individual Investors’ latest survey showed that bearish sentiment, or expectations of stock price falls over the next six month, has risen sharply to 59.4%. This level of bearishness was last seen in March 2009 when there were financial crises.

Bears on the prowl https://graphics.reuters.com/USA-STOCKS/FED/dwvkryqlypm/chart.png

This weak sentiment could be an indicator of stocks’ strength. With a 4-week average negative 29 percentage point spread between bears and bulls in AAII’s latest survey, the net spread fell to negative 43 percent.

Since 1987, when such an average four-week spread has been below negative 10 percentage points, the S&P 500 has risen 15.5% on average over the next 12 months, according to RBC Capital Markets.

How stocks do when investors are bearish https://graphics.reuters.com/USA-STOCKS/FED/myvmnyqqwpr/chart.png

Some investors believe the stock market may be poised for a rally in short term, if Wednesday’s Fed meeting doesn’t catch them by surprise. Following the Fed’s last meeting in March, the S&P 500 rallied 8% in the two weeks after the central bank raised rates by 25 basis points, as expected.

Traders in the options market remain cautious, with some measures of sentiment, including the put-to-call ratio of open contracts on the SPDR S&P 500 ETF (NYSE:) close to the most bearish they have been in recent years, according to Trade Alert data. If sentiment changes abruptly, excessive bearishness can drive strong rallies.

“The sentiment is really bad… Everything is starting to line up to be very oversold and overdone in the short term,” said Walter Todd, chief investment officer at Greenwood Capital in South Carolina. “Assuming you don’t get a big hawkish surprise out of the Fed, you could see a rally.”