Robust global economic growth could offer stocks enough support to resume a record rally, even if bets on a Federal Reserve interest rate cut this year are completely abandoned.
After the S&P 500’s best week since November pushed the U.S. stock index back to its March highs, investors are wondering if weakness seen earlier this month was just a blip or whether a late easing of policy would lead to a slowdown. the market is falling again.
The answer, some investors say, lies in the market model of the 1990s, when stocks more than tripled in value despite years of rates hovering around current levels. Back then, robust economic growth allowed stocks to shine, and even though the global outlook is more uncertain at present, there is still enough momentum to push the stock market higher.
“You have to evaluate why you might end up in a scenario where there are fewer rate cuts this year,” Zehrid Osmani, Martin Currie fund manager, said in an interview. “If this is due to a healthier-than-expected economy, it could support the recovery of stock markets after the typical knee-jerk and volatile reactions.”
Before last week’s gains, stocks had taken a break throughout April after early expectations of policy easing sparked record rallies in U.S. and European stock markets in recent months of 2023.
Traders’ expectations of at least six 25 basis point cuts from the Fed this year in early January have since been reduced to just one, as American inflation remains high, raising fears that prolonged restrictive policy could weigh on the economy and the profit potential of companies.
Rising geopolitical risks and uncertainty over the outcome of global elections have also caused increased volatility, boosting demand for hedges this would provide protection in case the market experiences a more brutal rout.
Nonetheless, confidence in the global economy has strengthened this year, supported mainly by US growth and recent signs of an economic slowdown. rebound in China. Likewise, the International Monetary Fund this month raised its forecasts for global economic expansion while a Bloomberg survey shows that eurozone growth is expected to accelerate from 2025.
Although recent economic data reflects a strong slowdown in US economic growth Last quarter, these figures should be “taken with a grain of salt” because they mask otherwise resilient demand, said David Mazza, managing director of Roundhill Investments.
“Net net, I remain convinced that we don’t need rate cuts to get back to a more optimistic mood, but I think it’s going to be more difficult,” Mazza said.
Some near-term pullback is considered healthy for the S&P 500 after its rally to an all-time high in the first quarter. Between 1991 and 1998, the index fell as much as 5% several times before rising again, but without correction of 10% or more, according to data compiled by Bloomberg.
One drawback of the comparison is that the index now has a much greater concentration than in the 1990s.
The top five stocks today — Microsoft Corp., Apple Inc., Nvidia Corp., Amazon.com Inc. and Metaplatforms Inc. – are all from the technology sector and represent almost a quarter of the market capitalization, leaving the index vulnerable to sharper swings.
There are, however, other factors that bode well for stocks.
An analysis from BMO Capital Markets showed that S&P 500 returns tend to correlate with higher returns. Since 1990, the index has averaged annualized gains of nearly 15% when the 10-year Treasury yield was above 6%, compared to a return of 7.7% when the yield was below 4%, according to the ‘analysis.
“This makes sense to us, since lower rates can reflect sluggish economic growth, and vice versa,” Brian Belski, BMO’s chief investment strategist, wrote in a note to clients.
Over the past week, 10-year Treasury yields rose to a yearly high of 4.74% on limited prospects for policy easing.
Early results from the current reporting season suggest that about 81% of U.S. companies are beating expectations, even amid high interest rates. First-quarter profits are on track to rise 4.7% from a year ago, compared with a preseason estimate of 3.8%, according to data compiled by Bloomberg Intelligence.
Analysts expect S&P 500 earnings to jump 8% in 2024 and 14% in 2025, after moderate growth last year, according to data compiled by BI.
Profit forecasts could be even higher next year if rates fall to zero in 2024, said Andrew Slimmon, portfolio manager at Morgan Stanley Investment management.
This “validates the upside potential of stocks,” given that the market will anticipate these projections, he said. said on Bloomberg television earlier this month.
A booming economy will continue to support stocks even without a rate cut, said Bank of America Ohsung Kwon, corps strategist. The biggest danger to that assumption will be a slowdown in the economy while inflation remains high, he said.
“If inflation persists because of the dynamics of the economy, that’s not necessarily bad for stocks,” Kwon said. “But stagflation is.”
