Stock-market believers still say the economy will pick up

Stock-market believers are looking beyond the worst part of months for US equities and are holding bets on a rally in the back half of the year once the Federal Reserve stops raising interest rates.

The S&P 500 Index is coming off its worst week since Dec. 9, as hotter-than-forecast inflation data fueled speculation that the Fed will raise borrowing costs several times, possibly stopping in July. That’s a steeper path to policy tightening than investors were bracing for just a few weeks ago.

However, this largely follows the theory that has prevailed since the end of 2022: That equities will struggle in the first six months of the year before. gain strength in the second half. Technical stock-markets show that investors agree with this logic, because the S&P 500’s uptrend that started last fall continues despite the index losing 2.6% this month.

“We’re getting closer to the end of the Fed rate cycle and markets are going to start discounting that,” said Mary Ann Bartels, chief investment strategist at Sanctuary Wealth.

Of course, the risks of this view are many. Swaps traders saw a peak rate of around 5.4% in July, up from around 5% at the start of February. But a new paper argues that it should rise up to 6.5%, raising the specter of a so-called hard landing where the economy falls into a recession. In the rosier soft-landing scenario, the Fed curbs inflation while the economy continues to grow.

“The market can handle a terminal rate of 5.5%, but it can’t handle one of 6% or higher,” said Bartels “That’s really the markets.”

Alarming inflation numbers weren’t the only reason the S&P 500 was down for the week. Terrible predictions from bellwethers like Walmart Inc. and Home Depot Inc. This week brought many signs of consumer health, with earnings updates from Batas corp. and Lowe’s Cos.

Stock market declines can be discouraging, but they are not a shock based on historical standards. Over the past 25 years, February was one of the worst months for the S&P 500, averaging a loss of 0.4%, according to data compiled by Bloomberg. The benchmark gauge fell 2.6% this month after jumping 6.2% in January.

For Bartels, any pullback in the coming weeks and months could be a buying opportunity. He favors aerospace and defense stocks, along with semiconductors, which have bounced back after a brutal 2022.

He was not alone. Ryan Detrick, chief market strategist at the Carson Group, is sticking with his bet that the US economy will go through a recession. He thinks that inflation will rise further, and if the rates stay higher for a longer period he recommends small companies and large industrials.

Prepare to eat

“The stage is still set for the US economy to accelerate in the second half of the year on a strong consumer base,” he said. “That will be a boon for equities.”

The Fed’s next rate decision is almost a month away, leaving the market plenty of time to absorb the deluge of inflation, labor market and wage growth numbers. Traders are bracing for the Fed’s possible return to jumbo hikes: Overnight index swaps are pricing in about 30 basis points of tightening for the March 22 announcement, and two-year Treasury yields have touched new highs since 2007 on Fridays.

That’s a toxic backdrop for growth stocks, whose valuations are more sensitive to changes in interest rates. Those shares have seen strong rallies to start this year on speculation that the Fed will soon end its hikes. As less likely, the tech-heavy Nasdaq The 100 fell 1.7% on Friday, outpacing the S&P 500’s decline.

But even so, the bull case for stocks is still in place as long as the Fed stays on the path it set last year, according to Michael Antonelli, market strategist at Baird.

“Inflation never falls in a straight line after peaking,” he said. It would take a full quarter of warmer-than-expected inflation and jobs data to force the Fed to dramatically raise its projections for its terminal rate, he estimated.

“The market doesn’t necessarily hate rate hikes,” he said. “It’s hated when the hikes are bigger than expected or faster than expected.”

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