With US interest rate cuts looming, the chances of an economic “soft landing” could determine equity performance
Aug 26 (Reuters) – With rate cuts virtually a done deal, investors will be increasingly focused on economic data over the next few months to see if the “soft landing” narrative that has boosted U.S. stocks in 2024 can continue.
“The market wanted to hear that the rate-cutting cycle was starting,” said Alessio de Longis, senior portfolio manager and head of investments at Invesco Solutions.
But “is the Fed trying to tell us that it is now actually worried about the economy? And if that is the case, then perhaps the excitement about the tightening cycle should be put in a different perspective.”
History shows that stocks tend to perform much better when rate cuts occur against a backdrop of robust growth rather than during a sharp economic downturn. Since 1970, in non-recessionary times, the S&P 500 has risen an average of 18 percent a year after the first rate cut, according to strategists at Evercore ISI. In recessionary times, the index rose an average of just 2 percent per year after the first cut.
Other important upcoming data includes two monthly inflation reports: the Personal Consumption Expenditure Price Index on August 30 and the Consumer Price Index on September 11.
Further signs of economic weakness could unsettle equity markets again and raise expectations for a 50 basis point cut in interest rates next month. Expectations for such a move were around 35 percent on Friday afternoon, compared with about 29 percent before the speech. The rest were expecting a 25 basis point cut, futures data showed.
“The Fed is easing monetary policy even though the economy is not particularly weak (and inflation is still above target), and it has the potential to ease significantly in response to any acute weakness,” Rick Rieder, BlackRock’s chief investment officer for global fixed income, wrote in a note on Friday.
Quincy Krosby, chief global markets strategist at LPL Financial, said a key factor for equity markets will be whether interest rate cuts occur because inflation is easing or the labor market is weakening.
“The market wants a rate-cutting cycle because inflation is falling,” Krosby said. “The question remains whether or not there will be a further deterioration in the labor market.”
Encouraging data could also help bolster stock prices at a time when some expect turbulent trading. September is historically the weakest month for stock performance, with the S&P 500 averaging a 0.78 percent decline since World War II, according to data from CFRA.
Increased stock valuations could also make investors less willing to hold on to their stocks when there is bad news. The S&P 500’s price-to-earnings ratio is 21, according to LSEG Datastream, up from 19.6 in early August. The index’s long-term average is 15.7.
“The longer-term trends in equities are rock solid and any weakness is an opportunity to increase exposure,” said Andre Bakhos, managing partner of Ingenium Analytics LLC. In the short term, “we’re going to see … choppy, erratic, volatile moves because nobody really knows what’s happening now that he (Powell) has revealed his cards.”
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Reporting by Lewis Krauskopf in New York; additional reporting by Bansari Mayur Kamdar in Bengaluru; Writing by Ira Iosebashvili; Editing by Matthew Lewis
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