The S&P 500 has surged 12% since June 16 on optimism that a weak economy could limit the Fed’s rate hikes.
But the index is still down 14% so far this year and is likely to keep falling for several reasons. First, the Fed has made it clear that its priority is to fight inflation.
The consumer price index soared 9.1% in the 12 months through June to a 40-year high. And the Fed’s preferred inflation gauge, the personal consumption expenditures price index, also hit a 40-year high in June at 6.8%.
With gasoline prices falling, inflation is likely to have peaked. But with many other prices still rising and supply chains still out of control, it’s unlikely to get anywhere near the Fed’s 2% target anytime soon.
Continue to raise interest rates
That means the central bank may not be giving up on the rate hike accelerator anytime soon. It is inflation and rising interest rates that have weighed on stocks so far this year.
When the Fed does turn to cutting rates, that could mean a recession. That’s obviously a bad thing for the stock, as it could weigh down earnings.
Many economists point out that the stock market remains fragile.
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“Looking at the repricing of cyclical assets in the U.S. and EU, we think markets may be overly complacent on expectations of a more accommodative monetary policy stance that prematurely fades recession risks,” Goldman strategists wrote in comments.
“We believe markets will be vulnerable to hawkish surprises if inflation continues to struggle to reset, and to growth surprises if slower activity leads to a longer/deeper downturn.”
Bank of America skeptical; JPMorgan optimistic
Bank of America strategists are also skeptical of the recent stock market rally. “We see this as a bear market rally, which is common, with an average of 1.5 per bear market since 1929,” they wrote in their comments.
“Historically, August and September are also the seasonally weakest months (up 0.1% in August and September vs. 1.1% in the month). We maintain our year-end target of 3,600 for the S&P 500. “
The 3,600 level is down 12% from the recent quote of 4,095.
To be sure, JPMorgan strategists are bullish on stocks. “While the current stock multiple is in line with the historical median, we believe it outperforms fair value given the shift in the industry mix towards higher quality companies,” they wrote in their comments.
“While the outlook for activity remains challenging, we believe the risk-reward for equities looks more attractive as we head into the second half of the year.”