Mitch on the Markets

April 22nd, 2024

How Badly Are Rate Cuts Needed In This Bull Market?

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How Badly Does the Bull Market Need Rate Cuts?

The latest inflation data in March’s consumer price index (CPI) report sent the stock market into a volatile trading session. The Labor Department reported that prices for all items rose 3.5% year-over-year in March, which was slightly higher than economist expectations and marked an acceleration from February’s 3.2% print. On a month-over-month basis, prices rose 0.4%, which was also 0.1% higher than the street was expecting.1

Stocks and bonds sold off, and traders immediately started dialing back bets for rate cuts in 2024. One month ago, markets were expecting about 100 basis points of cuts in 2024, with many expecting the first cut at the April 30 – May 1 meeting. After the CPI release, these expectations were slashed to 40 basis points for the year or slightly less than two moves.

CPI (blue line) ran hotter than expected in March

Source: Federal Reserve Bank of St. Louis2

Shifting Interest Rate Expectations May Not Break the Bull, But It Could Cause Volatility

Stubborn inflation and the expectation for fewer rate cuts in 2024 could agitate equity markets. And if uncertainty continues to rise—whether because of inflation, interest rates, or the U.S. presidential election—that could drive volatility, too. It’s crucial that investors take a clear-eyed approach to the stock market, in our view.

That’s why today I am pleased to offer our free April 2024 Stock Market Outlook3, where you’ll find insights on:

• March sell-side and buy-side consensus at a glance
• Whether the U.S. consumer can save the economy
• Zacks Rank S&P 500 sector picks
• Top-down S&P 500 yearend 2023 and 2024 targets
• Zacks rank March industry tables
• And much more!

If you have $500,000 or more to invest and want ideas on how to invest in a strong market, click on the link below to get your free report today!

IT’S FREE. Download the April 2024 Stock Market Outlook3

Fed Chairman Jerome Powell seemed to cement the dimming expectations for rate cuts last week when in a moderated question-and-answer in Washington he stated that “the recent data have clearly not given us greater confidence and instead indicate that it is likely to take longer than expected to achieve that confidence,” adding that “given the strength of the labor market and progress on inflation so far, it’s appropriate to allow restrictive policy further time to work.

In non-Fed speak: there’s no hurry to cut rates.

As I’ve written before, many market participants and a large swath of financial media have adopted the narrative that the stock market’s fate is in the Fed’s hands. Since expectations for rate cuts have been a key driver of the equity market rally, the thinking goes, that taking them away means introducing a major headwind for stocks.

I don’t buy that.

For one, it’s clear in the current environment that the Fed believes policy is sufficiently restrictive, meaning there’s no expectation that interest rates will go any higher. The debate remains around when the Fed will ultimately cut, and by how much. Not whether or not they’ll ever take that action.

Second, it’s important to contextualize why the Fed is choosing to hold rates where they are. If it’s because economic growth is good and the labor market is strong—but inflation is just being a bit stubborn—then investors can read this as a largely positive backdrop for corporate earnings and stocks. From 1950 to 2022, when headline CPI was running at a 3% to 5% annual pace (which we are now with the 3.8% print), the S&P 500 averaged an +8.5% annual forward 12-month return. When CPI falls into the 2% to 3% range—which I still expect this year—the S&P 500’s forward 12-month return jumps to +13.8%.

I would also add that if the Fed feels the need to tick interest rates even higher because of what they see as too-strong economic growth, that would not turn me bearish. History tells us that rising interest rates do not necessarily have to mean falling stocks – in fact, the opposite has been true throughout history:

Source: Federal Reserve; Bloomberg4

In my view, the risk is not that inflation remains somewhat sticky, prompting the Fed to cut only once or twice in 2024, or not at all. What would hurt markets is if inflation and inflation expectations start to drift higher and become un-anchored from their current 2.5% to 3.5% level, perhaps because of some unforeseen shock in geopolitics or the global economy. If the Fed is forced to go in the other direction—raising rates instead of cutting them because of a negative inflation surprise—we could see this impact risk assets adversely. In my view, this is a tail risk in 2024, not a prominent one.

Bottom Line for Investors

Take another look at the CPI chart above. The blue line illustrates sticky headline CPI, but the red line is the Fed’s preferred inflation measure, the headline PCE price index. Its latest reading (for February 2024) was 2.5% year-over-year, well within striking distance of the Fed’s 2% target. And, given the CPI and Producer Price Index (PPI) inputs that factor into PCE calculations, we expect the March 2024 headline PCE price index to come in at around 2.7% or 2.8%. No need to sound any alarm bells yet.

To better navigate through today’s market turbulence, I recommend downloading our free April 2024 Stock Market Outlook Report5. This report shares our expert market commentary and the latest forecasts on:

• Zacks Rank S&P 500 sector picks
• Current asset allocation guidelines
• Zacks forecasts for the months ahead
• Zacks Rank industry tables
• Buy-side and sell-side consensus at a glance
• And much more!

If you have $500,000 or more to invest and want to learn more about our market forecasts for 2024, click on the link below to get your free report today!

Disclosure

1 J.P. Morgan. April 12, 2024. https://www.jpmorgan.com/insights/outlook/market-outlook/tmt-does-it-matter-if-the-fed-cuts?jp_cmp=pw/ContentSharedViaAdvisorChannel/ema/OFTtemplate04122024&mkt_tok=Mzc3LVJFUS05NTcAAAGSc7pl0aVGuFOf8-K2PCWat3z-5O7a_iS-r_b_8mT05Ylm9SQQlnj4EQhENSh1ctEPi39hO5aLsWLFp-K2aTc8aikxei5Za2OQBDSLNOpBfc0jrA

2 Fred Economic Data. April 10, 2024. https://fred.stlouisfed.org/series/CPIAUCSL#

3 Zacks Investment Management reserves the right to amend the terms or rescind the free-Stock Market Outlook Report offer at any time and for any reason at its discretion.

4 Bloomberg. 2024. https://www.washingtonpost.com/business/stocks-dont-rise-or-fall-because-of-interest-rates/2022/01/25/25d23e7c-7dd7-11ec-8cc8-b696564ba796_story.html

5 Zacks Investment Management reserves the right to amend the terms or rescind the free-Stock Market Outlook Report offer at any time and for any reason at its discretion.

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