Could stocks be headed for a lot more upside? Assuming there is no recession, and interest rates drop as forecast, a lot of strategists think the answer is yes.
Seemingly everyone is convinced that the Federal Reserve will lower rates at its September 18 meeting. The CME Group’s FedWatch tool, based on a survey of interest rate traders, gives odds of 53.5% that the Fed’s policymaking committee will cut the body’s short-term fund rate by one-quarter of a percentage point, to a band between 4.75% and 5.0%.
The stock market could not be happier, advancing 1.7% Tuesday—part of an August reversal from the mini-slump that began in mid-July. Recall that the Fed’s early-2022 decision to hike rates, aimed at combating then-resurgent inflation, led to a year-long dive in 2022 (when the S&P 500 lost 18%). After that, the market resumed its upward path. Now inflation is ebbing, and expectations are strong that Wednesday’s Consumer Price Index announcement for July will continue to soften.
According to FactSet, the CPI likely rose on a monthly basis by 0.2% in July after falling 0.1% in June. The new report is “going to be bringing more evidence that the disinflation process continues and remains on track,” says Lydia Boussour, a senior economist at EY-Parthenon, told Morningstar. That development, she added, “will reinforce the case for a Fed rate cut at the September meeting.”
The periodic downturns, in fact, are too often the result of jumpy traders who fail to look at the broader picture, in the view of Jeremy Grantham, co-founder of investment firm GMO, in remarks to Barron’s. Coming from Grantham, a long-time bear, this is a telling observation. To Grantham, investors are overreacting to the stock market’s high valuation. The S&P 500’s price/earnings ratio is 23, about seven points higher than its average.
The promise of continued runway for tech stocks burns brightly to folks like Grantham, especially the latest tech iteration, artificial intelligence.
But even if the steady march up comes true, the occasional pullback is to be expected. Adam Turnquist, chief technical strategist at LPL Financial, wrote in a recent commentary that market downturns are similar to “a stubbed toe:” a temporary pain. Since 1928, per a Ritholtz Wealth Management study, 94% of years have had a drawdown of 5% or worse.
Still, today’s bearish qualms—a heated presidential contest, wars in Gaza and Ukraine, memories of recent inflation—make the investing public wary. The VIX index, which measures investor anxiety, spiked to 35 a week ago, amid a weak jobs report, but quickly settled back to 18, only slightly higher than it has been for the last couple of years.
Tags: CPI, Federal Reserve, Inflation, Interest Rates, Jeremy Grantham, S&P 500, Stock Market, VIX index