Interest Rates to Boost Economy and Investments
Last week’s inflation report stirred the markets, shifting the focus to the Federal Reserve. Traditionally, rate cuts are associated with economic issues or weaknesses, signaling potential downsides for stocks. However, despite the current resilience of the economy, the Fed is likely to announce a rate cut on September 18th. With inflation decreasing and the job market showing signs of weakening, it is time to lower interest rates to stimulate growth.
Various sectors of the economy, such as housing and manufacturing, are displaying significant weaknesses. While short-term volatility may persist, a more accommodating monetary policy is expected to spur growth and enhance liquidity. This positive environment is favorable for high-quality stocks and other risk assets. The anticipation is for the Fed to kick off with a 50 Bps rate cut, a move that should be well-received by the markets.
Corporate earnings remain robust, and despite potential slowdowns in certain sectors like AI, future quarters could see improved and better-than-expected earnings. Valuations, though elevated, are not at extreme levels, hinting at substantial upside potential in the ongoing bull market. As a result, the year-end target for the S&P 500 remains at 6,200.
The Technical Image – A Triple Top?
While some may argue against the existence of triple tops in trading, the S&P 500 is approaching a potential triple top formation. However, there is a high likelihood that the index will break out of this pattern. A constructive technical correction in July and early August saw the SPX dip by around 10% to the 5,200 support level. Following a successful re-test of this support, the SPX appears poised for another upward movement.
Data This Week – The FOMC Approaches
This week’s data points are overshadowed by the upcoming Federal Open Market Committee (FOMC) meeting and the expected rate cut decision. The key question on everyone’s mind is whether the Fed will opt for a modest 25 Bps cut or a more substantial 50 Bps cut. While the market may favor the latter, the important takeaway is the Fed’s shift towards a more accommodative monetary stance. Any initial negative market reaction to a 25 Bps cut is likely to be short-lived, presenting a buying opportunity in the near future.
Rates Likely Going Lower Quickly
Forecasts indicate a significant reduction in interest rates by early next year, with an estimated 80% probability of the funds rate dropping to 3.75-4% or lower by January 2025. This substantial decrease from the current benchmark rate environment signals a series of potential rate cuts in the coming months. The Fed is expected to adopt an aggressive approach towards lowering rates, including the possibility of jumbo 50 Bps cuts as part of its policy adjustment.
The easing cycle could see rates declining further beyond the initial phase, with projections suggesting a benchmark rate around 3% by mid-2025. This trend underscores the Fed’s commitment to supporting growth and employment through a more accommodative monetary policy. The expected easing measures, including potential future quantitative easing (QE) programs, aim to provide stability and liquidity to the markets in the years ahead.
Earnings Season Approaches
Despite the recent conclusion of the earnings season, another round is on the horizon. Positive results and solid guidance from the previous season set the stage for potential outperformance in the upcoming reports. Big names like JPMorgan are scheduled to report in early October, marking the beginning of a crucial period for stock performance leading up to the year-end holiday season.
The Valuation Perspective
The S&P 500’s forward P/E ratio, though relatively high at around 22-23, appears reasonable in the context of an easing monetary cycle in a stable economic environment. Anticipated improvements in growth and earnings could drive the forward P/E ratio even lower by 2025. Similarly, the Nasdaq 100’s forward P/E ratio, currently around 29, may see a slight decrease relative to future earnings, indicating a more optimistic outlook for tech companies.
While the Shiller P/E ratio for the S&P 500 is currently at 36, historically on the higher side, the potential for further appreciation suggests room for growth. As the market cycle progresses, earnings, valuations, and stock prices could continue their upward trajectory. The overall positive technical and fundamental outlook supports the maintenance of the SPX year-end target at 6,200.
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