© Reuters. FILE PHOTO: A street sign points to Wall Street outside the New York Stock Exchange (NYSE) in New York City, where markets are roiled after Russia continues to attack Ukraine, in New York, U.S., on February 24, 2022. REUTERS/Caitlin Ochess/File Photo
Written by David Randall
NEW YORK (Reuters) – The rally in U.S. stocks faces a potential inflection point next week as the Federal Reserve is expected to deliver what may be its most aggressive final rate hike in decades.
As the year began, many investors expected higher interest rates to trigger a recession that would further hurt stocks after a sharp decline in 2022. Instead, the US economy has proven resilient even as the Federal Reserve makes progress in its fight against inflation – a perfect “Goldilocks scenario” that many believe will boost stocks. It is up nearly 19% year to date and closed Thursday at 4,534.87, just about 6% below the high recorded in January 2022.
While investors widely expect the central bank to raise interest rates by 25 basis points at its meeting on July 26, many are also hoping for signs that policymakers are more confident that inflation will continue to slow, negating the need for the Fed to raise borrowing costs further and backing up the thesis that has helped prop up stocks in recent weeks.
“A large portion of the market is still macro-driven, and inflation is still driving. What the Fed does and says next week will be critical,” said Cliff Corso, chief investment officer at Advisors Asset Management.
Expectations of a benign macroeconomic backdrop and an end to Fed tightening have prompted some analysts to revise their views on how stocks will rise this year.
Credit Suisse’s Jonathan Gollob on Tuesday raised his year-end target on the S&P 500 to 4,700 from 4,050, citing a stronger economic outlook and expectations of strong earnings in technology and telecoms.
Fundstrat Global Advisors’ Tom Lee raised his year-end target to 4,825 earlier this month, while Yardeni Research’s Ed Yardeni sees the S&P 500 reach 5,400 in the next 18 months.
Meanwhile, a measure tracked by the National Association of Active Investment Managers showed stock pickers’ exposure to equities to its highest levels since November 2021, months before the Federal Reserve began its rate-raising cycle.
“The bears had to give up,” said Liz Ann Saunders, the firm’s chief investment analyst. Charles Schwab (NYSE:). “We’re seeing the underlying backdrop of lower inflation, resilient economic data, better consumer confidence, and a falling dollar, and that’s a very good recipe for gains.”
Eric Friedman, chief investment officer at US Bank Wealth Management, has increased his stock holdings in recent months and is growing optimistic in the technology sector on the expectation that corporate earnings will improve while the economy remains resilient.
“Consumers have been helped by a tight job market and some solid real wage gains, and at the same time we’re seeing some real progress on the inflation front,” he said.
At the same time, predictions of a recession — seen as all but a foregone conclusion at the start of the year — are becoming less dire.
Goldman Sachs (NYSE: ) on Monday cut the probability of a U.S. recession starting in the next 12 months to 20% from a previous forecast of 25%, assuming that easing inflation can open the way for the Federal Reserve to cut interest rates without precipitating a decline. Last month, the bank raised its year-end target for the Standard & Poor’s 500 index to 4,500 from 4,000.
However, many strategists remain bearish, chalking up from shortcomings during the ongoing earnings season to surprises in the continuity of inflation.
Sunita Thomas, Senior Portfolio Manager Northern Trust (NASDAQ:) believes that inflation will prove more stubborn than expected and has reduced exposure to stocks in recent months.
“We’ve told clients that the market has been doing very well for very good reasons, but now is the time to rebalance,” she said.
Rising valuations was another concern, as the S&P 500 now trades at 20.8 times forward earnings, from about 16 times at the start of the year.
However, Christopher Tsai, chief investment officer of Tsai Capital, is not worried about buying into an overvalued market. It has added eight companies to its portfolio this year, including index provider MSCI Inc and animal health company Zoetis Inc (NYSE: ), which he believes has been overlooked in the market’s advance.
“It’s hard to find names that are so exaggerated,” he said.