Relentless U.S. stock rally faces Fed test
The U.S. stock market rally faces a critical juncture in the coming week as the Federal Reserve is expected to execute what could be the final rate hike of its most aggressive monetary policy tightening cycle in decades.
At the start of the year, many investors were concerned that higher interest rates might trigger a recession and further dampen stocks following the sharp decline in 2022. However, contrary to those expectations, the U.S. economy has displayed resilience even as the Fed made progress in combating inflation, creating an ideal “Goldilocks scenario” that many believe will continue to support equities. The S&P 500 has surged nearly 19% year-to-date, and as of Thursday’s close at 4,534.87, it stands only about 6% below the all-time high reached in January 2022.
While the prevailing consensus is that the central bank will raise rates by 25 basis points at its July 26 meeting, investors are also hopeful for signals that policymakers are more confident in the continued cooling of inflation. Such indications could lead to reduced expectations for further rate increases, thereby supporting the thesis that has bolstered stock markets in recent weeks.
Cliff Corso, Chief Investment Officer at Advisors Asset Management, emphasizes the market’s macro-driven nature and the critical role of the Fed’s actions and statements in shaping investor sentiment going forward.
Anticipations of a favorable macroeconomic backdrop and a potential end to the Fed’s tightening measures have prompted some analysts to revise their views on the stock market’s potential for the remainder of the year. Notably, Jonathan Golub of Credit Suisse raised his year-end target on the S&P 500 to 4,700 from 4,050, citing an improved economic outlook and strong expectations for technology and communication service earnings. Other analysts, such as Tom Lee of Fundstrat Global Advisors and Ed Yardeni of Yardeni Research, have also revised their year-end targets upwards.
The increased exposure to equities among active investment managers and the optimistic sentiment from various strategists further highlight the current bullish outlook for the stock market. Despite concerns about potential shortfalls during the ongoing earnings season and uncertainties surrounding inflation durability, many investors remain confident in the market’s ability to continue its upward trajectory.
The probability of a U.S. recession starting in the next 12 months has been reduced, with Goldman Sachs now forecasting a 20% probability compared to an earlier estimate of 25%. The bank also adjusted its year-end S&P 500 target to 4,500, up from 4,000.
However, not all strategists share the same optimism, as some remain cautious due to concerns about stubborn inflation and rising valuations. Valuations have been a particular worry, with the S&P 500 currently trading at 20.8 times forward earnings, up from around 16 times at the start of the year.
Despite these concerns, some investors like Christopher Tsai, Chief Investment Officer at Tsai Capital, continue to find opportunities in the market. Tsai has added several companies to his portfolio, believing that they have been overlooked in the market’s overall advance.
In summary, the stock market’s performance next week will be significantly influenced by the Federal Reserve’s actions and statements. While the economic outlook remains resilient and many analysts are optimistic about the market’s potential, some cautionary notes about inflation and valuations persist. As the landscape evolves, investors continue to adjust their strategies and remain vigilant for potential opportunities and challenges.
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