Title: Relentless U.S. Stock Rally Faces Fed Test amid Rate Hike Expectations
The relentless rally in U.S. stocks is poised for a potential turning point as the Federal Reserve gears up to deliver what could be the last rate hike of its aggressive monetary policy tightening cycle. Investors began the year anticipating higher interest rates that might trigger a recession, leading to further declines in stocks after the sharp downturn in 2022. Surprisingly, the U.S. economy has demonstrated resilience even as the Fed tackles inflation, creating an ideal scenario that many refer to as Goldilocks – one that is expected to support equity markets. Currently, the S&P 500 is up nearly 19% year-to-date, closing at 4,534.87 on Thursday, just 6% shy of its all-time high reached in January 2022.
While the general consensus is that the central bank will raise rates by 25 basis points at its July 26 meeting, investors are hopeful for indications from policymakers that they are growing more confident in taming inflation. Should inflation continue to cool down, it would eliminate the need for the Fed to raise borrowing costs significantly, which would bolster the thesis that has recently lifted stocks. The upcoming Fed meeting is vital for the market’s macro-driven faction, with inflation playing a central role. What the Fed does and says next week will be critical, said Cliff Corso, chief investment officer at Advisors Asset Management.
Anticipating a benign macroeconomic backdrop and the end of Fed tightening, analysts have adjusted their expectations for how high stocks could climb this year. Jonathan Golub of Credit Suisse raised his year-end target for the S&P 500 to 4,700 from 4,050, citing a stronger economic outlook and expected robust earnings in the technology and communication service sectors. Tom Lee of Fundstrat Global Advisors increased his year-end target to 4,825 earlier this month, while Ed Yardeni of Yardeni Research sees the S&P 500 reaching 5,400 in the next 18 months.
Concurrently, a gauge tracked by the National Association of Active Investment Managers revealed that stock pickers’ exposure to equities is at its highest level since November 2021, months before the Fed started tightening rates. Bearish investors have had to capitulate, commented Liz Ann Sonders, chief investment strategist at Charles Schwab. We’re seeing a fundamental backdrop of lower inflation, resilient economic data, better consumer confidence, and a falling dollar that’s a pretty good recipe for gains.
Eric Freedman, chief investment officer at U.S. Bank Wealth Management, has been increasing his stock holdings in recent months, becoming more bullish on the tech sector. He expects companies’ earnings to improve as the economy continues displaying resilience, supported by a tight job market, wage growth, and progress in fighting inflation.
However, some strategists remain bearish, expressing concerns about potential earnings shortfalls during the ongoing earnings season and the unpredictability of inflation’s longevity. Sunitha Thomas, senior portfolio manager at Northern Trust, believes that inflation will prove more persistent than expected and has reduced exposure to equities in recent months. She advises clients to rebalance their portfolios given the favorable performance of the market.
Another worry is rising valuations, with the S&P 500 currently trading at 20.8 times forward earnings, up from around 16 times at the beginning of the year. Nonetheless, Christopher Tsai, chief investment officer at Tsai Capital, is not alarmed by the prospect of investing in an overvalued market. He has added eight companies, including MSCI Inc. and Zoetis Inc., to his portfolio this year, believing these stocks have been overlooked amid the market’s surge. It’s hard to find names that are massively overvalued, he noted.
According to Goldman Sachs, the likelihood of a U.S. recession in the next 12 months has decreased to 20% from an earlier forecast of 25%. The bank believes that easing inflation could create room for the Fed to lower rates without triggering a downturn. Last month, Goldman Sachs raised its year-end target for the S&P 500 to 4,500 from 4,000.
As the market continues to navigate the Federal Reserve’s decision-making and assess the ongoing earnings season, experts hold varied perspectives on the potential trajectory of U.S. stocks. While optimism remains high among some analysts, others remain cautious, providing a more balanced outlook on the market’s future. In this scenario, investors should carefully weigh the factors at play and consider options for portfolio rebalancing in order to capture the best opportunities while mitigating potential risks.
