Why stocks may still rise even as rate cut hopes fade

Investors are challenging when the Federal Reserve will start cutting interest rates, but many Wall Street strategists believe it won't happen. Change the payment of shares in 2024.

After a key inflation report last month showed an unexpected rise in consumer prices on Wednesday, investors are now pricing in 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 were largely resilient to moves in interest rate expectations this year, with the S&P up 8% year-to-date — so a shift in market expectations for central bank policy is unlikely to dampen the stock market's rally.

Christopher Harvey, chief investment strategist at Wells Fargo, raised his year-end target for the S&P 500 (^GSPC) to 5,535 on Monday, telling Yahoo Finance that the most important part of the Fed debate still lies in easing. pipe.

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

Market bulls are encouraged by limited signs that higher interest rates are dampening corporate earnings or US economic growth. Consensus estimates should increase revenue growth for the full year.

“It's really about earnings,” Bank of America and Canada equity strategist Ozung Kwon told Yahoo Finance, explaining why the S&P 500 could reach his firm's year-end S&P 500 target of 5,400 even if the Fed doesn't cut rates. This year.

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Kwon and other strategists who spoke with Yahoo Finance in recent weeks all expressed a similar sentiment: It doesn't matter when or how much the Fed cuts this year. It won't even kill the market rally if the Fed doesn't cut in 2024. What matters most is why the central bank cuts rates.

“As a bull, I'd like to see more Fed tapering because the economy is so strong that the Fed needs to cut because the economy is weakening,” Quan said.

'No landing' for stocks

A growing number of economists see the economic growth outlook improving because, if it slows, the likelihood that the central bank will cut rates lower than previously thought has risen. This is often referred to as a “no landing situation,” where the trajectory of inflation slows as economic growth accelerates.

Overall, that's not bad for the major indexes, which comes with a positive economic growth backdrop, which is one reason strategists believe earnings growth will expand beyond tech later this year. However, this could create a further divide between large and small cap stocks.

In a weekly note on Sunday, Morgan Stanley Chief Investment Officer Mike Wilson wrote of recent cyclical leadership from sectors such as Energy (XLE), Materials (XLB), and Industrials (XLI).

Within those moves, according to Wilson's analysis, investors prefer large-cap companies. Small caps, Wilson noted, have shown greater rate sensitivity and have fallen more than the broader market on days when bond yields rise.

It emerged Wednesday as the 10-year Treasury yield ( ^TNX ) rose more than 20 basis points, the small-cap Russell 200 Index ( ^RUT ) fell nearly 3% and the S&P 500 fell less than 1%.

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The market action underscored that investor appetite for sectors such as small caps, which have high exposure to debt refinancing at current high interest rates, will remain muted until expectations of a rate cut continue to wane.

He added, “A reduction in rates could further stimulate the cycle for broad-based cycles and low-quality ones with poor balance sheets. Conversely, a further break in yields could lead us back into a short-market regime.”

WASHINGTON, DC - JANUARY 31: US Federal Reserve Board Chairman Jerome Powell speaks during a news conference at Federal Reserve Headquarters on January 31, 2024 in Washington, DC.  The Federal Reserve today announced no change in interest rates.  (Photo by Anna Moneymaker/Getty Images)

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

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

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