Following the Federal Reserve’s announcement on Wednesday, stocks plummeted due to the indication of prolonged elevated interest rates. Over a span of two days, the S&P 500 witnessed a significant drop of more than 2%, and the yield on the 10-year Treasury benchmark soared to its highest point in 15 years. Data from Bank of America revealed that investors swiftly divested equities at a pace not seen since December 2022.
However, some analysts believe the market’s response may be overly pessimistic. Tom Lee, the Head of Research at Fundstrat, voiced his dissent, stating, “The market had an overly hawkish reaction to the FOMC meeting,” in a video briefing to clients after Thursday’s market close.
Lee’s disagreement centers around a pivotal factor influencing market behavior. The Federal Reserve’s revised Summary of Economic Projections (SEP), released Wednesday, demonstrated a lean toward one additional interest rate hike this year. It also disclosed that the Fed envisions interest rates remaining higher than initially forecasted for both 2024 and 2025.
Yet, Lee contends that this development is not cause for major concern. He argues that the Fed’s extended period of higher rates aligns with the bolstered Gross Domestic Product (GDP) outlook. Fed Chair Jerome Powell underscored during his press conference that the impetus for another rate hike would be economic growth, projecting a 2.1% increase this year, a marked improvement from the 1% estimate in June, rather than inflation.
Lee posits that the convergence of elevated interest rates and increased GDP not only makes logical sense but could potentially lead to higher price-to-earnings ratios as the economy expands. This, in turn, may drive up stock valuations.
“A hawkish take would be inflation persistence went up and therefore Fed funds needs to stay high,” Lee conveyed in a note to clients on Friday. Nevertheless, he emphasizes that the Fed’s projections do not anticipate an inflation surge.
Furthermore, Lee underscores that these projections are just that—projections—subject to change by the Fed. Merely three months prior, the Fed anticipated an additional 0.5 percentage points’ worth of rate cuts in both 2024 and 2025 compared to its most recent forecast.
In addressing concerns about higher yields on Treasury notes, Lee remains unruffled. On Friday, the yield on the 10-year Treasury notes held steady at approximately 4.4%. Lee highlights that historically, when yields fluctuate between 3.5% to 5.5%, the average price-to-earnings ratio on the S&P 500 hovers around 20. This aligns with the P/E from 2019 and could potentially ascend even further.
“I don’t think this rise in yields is a thesis killer,” Lee asserted in the video. “Obviously it’s a headwind for stocks. I’d like to see yields come down but again I think the sell-off in the last couple of days is an overreaction.”
Finally, Lee underscores the influence of seasonality on market trends. September traditionally represents a challenging month for stocks. Nonetheless, Lee posits that overcoming this “seasonal weakness” could serve as a favorable tailwind for stocks. Ryan Detrick, Chief Market Strategist at Carson Group, shares Lee’s sentiment, citing instances where a decline of over 1% in S&P 500 in both August and September led to an 8% or more increase in the benchmark index come October.
In conclusion, the sharp decline in stocks underscores the market’s apprehension over the Federal Reserve’s decision to prolong elevated interest rates, prompting investors to reevaluate their strategies in light of this new economic landscape.
Source: Yahoo Finance
