Investors closely watch Fed rate cut and earnings to fuel market rally, analysts say

Investors closely watch Fed rate cut and earnings to fuel market rally, analysts say

By David Randall

NEW YORK (Reuters) – After a bumper start to the year for stocks, investors are wary of possible second-quarter twists and turns as they weigh whether the Federal Reserve factors in an expected interest rate cut by now June and focus on health. future gains.

The finished the first quarter with a gain of more than 10%, its biggest first-quarter gain since jumping nearly 13.1% in the first quarter of 2019. While so-called Magnificent Seven stocks such as the chipmaker Nvidia (NASDAQ:) and Facebook parent Meta Platforms (NASDAQ:) provided the bulk of the quarter’s gains as economically sensitive sectors such as energy and industrials rallied over the past six weeks.

Whether the recovery continues through June will likely depend on the Fed, which has yet to signal that inflation has fallen enough to warrant a rate cut. Markets began January with 6-7 cuts expected over the course of 2024, but are now expecting 3 cuts after signs of resilience in the U.S. economy increased investor confidence in a se -called soft landing.

“The market and the Fed are finally aligned on expectations, but that puts even more pressure on every economic report that comes out because it doesn’t take much to get everyone operating the same way,” Joe Kalish said , chief global macroeconomic strategist. at Research Ned Davis. “We expect more volatility if we don’t see more progress on the inflation front.”

Futures markets now imply a 61% chance of seeing a 25 basis point rate cut at the Fed’s policy meeting that ends June 12, bringing benchmark rates back to a range of 5 to 5.25 %, according to CME’s FedWatch tool.

Continued growth in the U.S. economy will likely continue the recent broadening of the market rally into cyclical sectors and small-cap stocks as investors seek more attractive valuations, said Jason Alonzo, portfolio manager at the Harbor Capital’s multi-asset strategies team. The index of small-cap stocks finished the first quarter with a 4.8% gain, while the S&P 500 industrial sector rose nearly 11% over the same period.

“Right now, the only thing the market cares about is whether the Fed will stay in control even if the economy reaccelerates,” Alonzo said. “If this idea were to be upended somewhat and the Fed were to suggest that rate hikes were on the table again, it would be a shock to investors and pose a real problem for all assets.”

Next week’s economic figures, including ISM manufacturing data, ISM services data, and the closely watched nonfarm payrolls report, which economists polled by Reuters expect to grow by 198,000 jobs in March.

Investors shouldn’t be surprised if the market’s rally begins to slow as the Fed nears a potential rate cut, noted Sam Stovall, chief investment strategist at CFRA Research. Since 1989, the S&P 500 Index has gained an average of 15.5% between the last rate hike in a cycle and the first rate cut, but has only gained an average of 5.4% over the six months. following the first rate cut, he said.

Still, strong momentum in the first quarter has historically carried over into the following quarter, said Keith Lerner, co-chief investment officer at Truist Advisory Services. Of the 11 times the S&P 500 posted a total return of 10% or more in the first quarter, the market continued to advance 9 times in the second quarter, with an average gain of 6.2%, he said .

“The market deserves the benefit of the doubt and, at this point, we believe the rules of the bull market apply,” Lerner said. The biggest risk to a continued recovery would be a sign that the Fed plans to keep rates at current levels until the end of the year, which would lead to a “dramatic” revaluation of risk assets, a- he declared.

The likelihood of a market downturn will also depend largely on corporate earnings, which have proven surprisingly robust and helped propel the S&P 500 to a series of record closing highs despite interest rate hikes. market, said Emily Roland, co-chief investment strategist at John Hancock Investment Management.

S&P 500 earnings grew at a pace of 10.1% in the final quarter of 2023, more than double the expected 4.7% gain, according to LSEG I/B/E/S. High interest rates will likely weigh on consumer and business spending, with analysts expecting profit growth of 5.1% in the first quarter. Companies begin to seriously publish their results from the second week of April.

“If earnings continue to surprise on the upside, the Fed will have a hard time justifying three cuts this year,” Roland said. “But if we see inflation stabilizing, this economic reacceleration could turn into something more sustainable.”

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