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How Stocks Could React to a Fed Pivot

How Stocks Could React to a Fed Pivot

Thoughts on the Market vor 1 Jahr

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Opinions by market pundits have been flying since Fed Chair
Powell’s remarks at Jackson Hole last week, leaving the door open
for interest rate cuts as soon as in September. Our CIO and Chief
U.S. Equity Strategist Mike Wilson explains his continued call
for a bullish outlook on U.S. stocks.

Read more insights from Morgan Stanley.

----- Transcript -----

Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan
Stanley’s CIO and Chief U.S. Equity Strategist. Today on the
podcast I’ll be discussing the Fed’s new signaling on policy and
what it means for stocks.

It's Monday, August 25th at 11:30am in New
York.

So, let’s get after it.

Over the past few months, the markets started to anticipate a Fed
pivot to a more dovish stance this fall. More specifically, the
bond market started to price in a very high likelihood for the
Fed to start cutting interest rates again in September. Equities
have taken their cues from this signaling in the bond market by
trading higher through most of the summer – despite lingering
concerns about tariffs, international conflicts and valuation. I
have remained bullish throughout this period given our focus on
historically strong earnings revisions and the view that the
Fed’s next move would be to cut rates even if the timing remained
uncertain.

Last week, the Fed held its annual symposium in Jackson Hole
where they typically discuss near term policy intentions as well
as larger considerations for their strategic policy framework. We
learned two key things.

First, the Fed seems closer to cutting rates in September than
the last time Chair Powell spoke
publicly. This change also comes after a
week in which the markets were left wondering if he would remain
more hawkish until inflation data confirmed what markets have
already figured out. Clearly, Powell leaned more dovish. And with
markets a bit nervous going into his speech on Friday morning,
equities rallied sharply the rest of the day.

Second, the Fed also indicated that it will no longer target
average inflation at 2 percent. Instead, it will make 2
percent the target at all times. This means the Fed will not
tolerate inflation above or below target to manage the average
like it did in 2021-22. It also suggests a more hawkish Fed
should the economy recover more strongly than is currently
expected or inflation reaccelerates.

From my standpoint, this is bullish for stocks over the next few
weeks and markets can now fully anticipate Fed cuts in September.
However, I see a few risks for September and October worth
thinking about as the S&P 500 approaches our longstanding
6500 target.

The first risk is the Fed decides to not cut after all because
either growth is better or inflation is higher than expected.
That would be worth a small correction in stocks given the high
likelihood of a cut that is now priced in.

The second risk is the Fed cuts but the bond market decides it’s
being too carefree about inflation and longer term bonds sell
off. A sharp rise in 10-year Treasury yields would likely
elicit a bigger correction in stocks until the Treasury and Fed
regain control.

Here’s the important message I want to leave you with. A major
bear market ended in April, and a new bull market began.

It’s rare for new bull markets to last only four months and more
likely they last one-to-two years, at a minimum. What that
means is that any dips we get this fall are likely to be buying
opportunities for longer term investors. What gives us even more
confidence in that statement is that earnings revisions continue
to move sharply higher. The Fed uses economic data to make its
decisions and that data is generally backward looking. Equity
investors look at company data and guidance which is forward
looking. This fact alone explains the wide divergence between
equity prices and Fed decisions, which tend to be late and after
equity markets have already figured out what’s going to happen
rather than what’s in the past.

Bottom line, I remain bullish on the next 12 months given what
companies and equity markets are telling us.

Thanks for tuning in; I hope you found it informative and useful.
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