May 18, 2024

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Why stocks can still rise even as interest rate cut hopes fade

Why stocks can still rise even as interest rate cut hopes fade

Investors are backing off their bets on when the Federal Reserve will start cutting interest rates, but many Wall Street strategists believe that won't happen. Equity fees change higher in 2024.

After the headline inflation report showed an unexpected rise in consumer prices last month on Wednesday, investors are now pricing in just two interest rate cuts in 2024, down from a peak of seven in early January.

Despite the market's pullback in reaction to the latest inflation data on Wednesday, stocks have been largely resilient to moves in interest rate expectations this year, with the S&P up about 8% so far – so the shift in market expectations of Reserve Bank policy Federalism is essential. It is unlikely to derail the stock market rally.

Christopher Harvey, chief investment strategist at Wells Fargo, who boosted his year-end target for the S&P 500 (^GSPC) to a Street high of 5,535 on Monday, told Yahoo Finance that the most important part of the Fed's discussion remains that easing is not… Still in progress. Pipeline.

“The big, important thing is that the Fed will start a multi-year easing cycle,” Harvey said. “We can argue about when, how much, but the reality is it is a multi-year easing cycle.”

Bulls are also encouraged by limited signals that higher interest rates are slowing corporate profits or U.S. economic growth. Consensus estimates suggest that earnings growth will rise over the course of the year.

“It's about… Right to profits.” this year.

Kwon and other strategists who spoke with Yahoo Finance in recent weeks expressed the same sentiment: It doesn't matter when or how much the Fed cuts this year. It may not even destroy the market rally if the Fed doesn't cut rates at all in 2024. What's more important is why the Fed cuts rates when it does.

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“As a bull, I would rather see the Fed cut rates less because the economy is so strong rather than have the Fed have to cut rates because the economy is weakening,” Kwon said.

“No fall” for stocks

A growing number of economists see the improving outlook for economic growth as creating a high chance that the Fed will cut interest rates less than previously thought, if at all. This is often referred to as a “no-fall scenario,” where economic growth accelerates while inflation slows downward.

Overall, this isn't all bad for the major indices since it would come with a positive economic growth backdrop, which is why strategists believe earnings growth could expand beyond technology later this year. However, this can lead to further bifurcation between large-cap and small-cap stocks.

In a weekly note on Sunday, Mike Wilson, chief investment officer at Morgan Stanley, wrote that recent cyclical leadership from sectors such as energy (XLE), materials (XLB), and industrials (XLI) suggests the market is moving into a “no bear” scenario.

As part of these moves, investors favored large-cap companies, according to Wilson's analysis. Wilson noted that small companies showed greater interest rate sensitivity and fell more than the broader market on days when bond yields rose.

That was on display on Wednesday, when the 10-year Treasury yield (^TNX) rose more than 20 basis points and the Russell 200 small-cap index (^RUT) fell nearly 3% while the S&P 500 fell less than 1%.

The market movement underscores that investor appetite for areas such as small caps, which have more exposure to debt refinancing at current high interest rates, will remain weak as long as expectations of interest rate cuts continue to decline.

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He added: “A decline in interest rates could stimulate a shift to a broader range of cyclical stocks and even lower quality ones with poorer balance sheets. Conversely, any rise in yields could push us back into a tight market regime.”

WASHINGTON, DC - JANUARY 31: U.S. Federal Reserve Chairman Jerome Powell speaks during a press conference at Federal Reserve Headquarters on January 31, 2024 in Washington, DC.  The Federal Reserve announced today that interest rates will remain unchanged.  (Photo by Anna Moneymaker/Getty Images)

Federal Reserve Chairman Jerome Powell speaks during a news conference at Federal Reserve headquarters on January 31, 2024, in Washington, D.C. (Anna Moneymaker/Getty Images) (Anna Moneymaker via Getty Images)

Josh Schaeffer is a reporter for Yahoo Finance. Follow him on X @_joshschafer.

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