Even if bets on the Federal Reserve cutting rates this year are completely abandoned, strong global economic growth could provide enough support to send stocks to another record rally.
The S&P 500’s best week since November pushed the U.S. stock index back to March’s record levels, but investors doubt the weakness seen earlier this month was just a blip. We are now facing the question of whether it was the real deal, or whether the delay in policy easing is pulling stock prices. The market fell again.
Some investors say the answer lies in the market strategies of the 1990s. At the time, the stock price more than tripled, even though interest rates had been hovering around current levels for years. At the time, solid economic growth provided a platform for stocks to shine, and although the global outlook is more uncertain at the moment, there is still plenty of momentum to propel stock markets forward.
“We need to assess why we are in a scenario where there are fewer rate cuts this year,” Martin Currie fund manager Zefrid Osmani said in an interview. He added: “If this is related to a healthier-than-expected economy, it could support stock market gains after a typically volatile and sudden reaction.”
Ahead of last week’s rally, stocks had taken a breather throughout April after initial hopes for policy easing sparked record gains in U.S. and European stock markets in the final months of 2023.
With U.S. inflation remaining high, traders had said in early January they expected the Fed to cut rates by at least six 25 basis points (bp) this year, but only once since then. , raising concerns that prolonged restrictive policies will weigh on the economy and earnings potential. companies.
Rising geopolitical risks and uncertainty around the outcome of global elections are also causing a spike in volatility, increasing demand for hedges to protect against sharper market declines.
Still, confidence in the global economy has strengthened this year, largely on the back of U.S. growth and recent signs of recovery in China. Similarly, the International Monetary Fund raised its forecast for global economic expansion this month, while a Bloomberg survey says growth in the eurozone is expected to accelerate from 2025.
Recent economic data reflects a sharp downturn in U.S. economic growth last quarter, but these numbers should be “taken with a grain of salt” as they hide resilient demand, said Round Hill Investments. CEO David Mazza said.
“Absolutely, I still believe that we don’t need rate cuts to get back to a more bullish mentality, but it’s going to get tougher going forward,” Mazza said.
After rising to an all-time high in the first quarter, the S&P 500 index appears to be healthy, although it has seen some short-term pullback. From 1991 to 1998, the index fell as much as 5% several times before making new gains, but never corrected more than 10%, according to data compiled by Bloomberg.
One drawback to this comparison is that the concentration of the index is much greater today than it was in the 1990s.
The current top five stocks (Microsoft, Apple, Nvidia, Amazon.com, and Metaplatforms) are all in the high-tech sector and account for nearly a quarter of the market capitalization. It is out of the index. Weak against sharp swings.
Still, there are other factors that bode well for the stock.
BMO Capital Markets analysis showed that S&P 500 returns tend to correlate with higher yields. The analysis shows that since 1990, the index has averaged nearly 15% annual gains when the 10-year Treasury yield is above 6%, compared with an average annual increase of nearly 15% when the yield is below 4%. was 7.7%.
“This makes sense to us because lower interest rates can reflect slower economic growth and vice versa,” Brian Belsky, chief investment strategist at BMO, said in a note to clients. said.
With prospects for limited policy easing, the yield on the 10-year U.S. Treasury rose to 4.74% over the past week, the highest level this year.
Early results from the current reporting season suggest that about 81% of U.S. companies are outperforming expectations, even against a backdrop of rising interest rates. First-quarter profit rose 4.7% from a year earlier, compared with preseason expectations of 3.8%, according to data compiled by Bloomberg Intelligence.
Analysts expect S&P 500 earnings to rise 8% in 2024 and 14% in 2025, after lagging last year, according to data compiled by BI.
Andrew Slimmon, a portfolio manager at Morgan Stanley Investment Management, said next year’s profit forecast could be even higher if a zero rate cut occurs in 2024.
He told Bloomberg TV earlier this month that given the market’s pre-emption of those predictions, “the upside potential for stocks has been proven.”
Ohsung Kwon, a strategist at Bank of America, said he thinks the strong economy will continue to support stock prices even without a rate cut. The biggest danger to this assumption is if the economy slows while inflation remains high, he said.
“Even if inflation is stagnant because of the strength of the economy, that’s not necessarily bad for stock prices,” Kwon said. “But stagflation is real.”
