Financial basis

Column: Wall Street refuses to give in to the Fed’s fiery outlook: McGeever

Traders work on the floor of the New York Stock Exchange (NYSE) in New York, U.S., January 25, 2022. REUTERS/Brendan McDermid/File Photo

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ORLANDO, Fla., Feb 1 (Reuters) – Stock market strategists’ reluctance to revise down their year-end forecasts for U.S. stocks is a curiosity emerging from the seismic shift in U.S. interest rate expectations these last weeks.

From relative bulls at BNP Paribas to relative bears at Bank of America, no one has downgraded their outlook for Wall Street, even as money markets now expect at least five quarter-point rate hikes. from the Federal Reserve this year.

Keep in mind that when the banks released their 2022 brochures late last year, barely 50 basis points of tightening had been factored in, take-off was not expected until the second half and the real 10-year Treasury yield was less than -1%.

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Some economists – like those at Morgan Stanley – did not expect the Fed to raise rates this year at all. But every Fed meeting is now “live” and US stocks have had one of the most volatile starts to the year ever.

Still, the prevailing vibe is “keep calm and buy the dip”.

Take Bank of America, whose economists last week released the Fed’s most aggressive forecast yet: seven quarter-percentage-point hikes this year, four more next year, and the funds rate feds peaking at 2.75%-3.00%.

That’s significantly more hawkish than their outlook at the end of last year of three rate hikes in 2022. Then the BofA equity strategists’ 2022 price target for the S&P 500 was 4,600. price today? Always 4600.

At BNP Paribas, the US equity strategy team had put 5,100 in its end-2022 forecast, as fellow economists predicted three Fed rate hikes of 25 basis points each.

The bank’s Fed call is now for six rate hikes, and the S&P 500 target is still 5100.

Higher interest rates should dampen equities as they increase the cost of corporate borrowing. They also have the mechanical effect of increasing the discount rate used to value future cash flows in the current stock price – especially for many tech and small cap stocks.

REAL RETURNS & MULTIPLES

So what gives?

On the macro front, recession still seems a distant prospect, even as growth forecasts fade and flattening pressures persist on the Treasury yield curve. As long as the economy is growing at a reasonable pace – comfortably north of 3% according to the consensus – corporate profits should hold up.

BNP Paribas’ Greg Boutle remains confident that Corporate America can post double-digit earnings growth this year – double the consensus of around 8% – which will offset headwinds from tighter financial conditions.

S&P500
Evaluation

He estimates that a 25 basis point rise in the 10-year real yield is equivalent to a decline of about 1.1 in US price-earnings ratios. At one point last week, price-earnings ratios had compressed by around 2.2, which is a rise from trough to peak in real yield of around 50 basis points.

Real yields have pulled back a bit, but Boutle says the January decline — the S&P 500 was down more than 10% and the Nasdaq nearly 20% at one point — is nothing to be alarmed about. The S&P 500 jumped almost 2% on Monday to end the month at 4,515 points.

“Market Fed prices inject the potential for a bit more turbulence, or headwinds in our view, but markets are efficient and forward-looking,” he said.

SHOP AT 10% OFF TOPS?

Basing his calculations on Friday’s close around 4432 points and the 10-year real yield at -0.60%, David Kostin of Goldman Sachs estimates that, all things being equal, the S&P 500 would drop 10% to 4000 if the yield increased by 60 basis points at 0%, and by 15% at 3800 if it increased by 100 bps.

But Kostin also says history shows that buying the S&P 500 10% off its peak generates a median return of 15% over the next year. Translated to today, this puts the index at 4975.

“Market corrections are usually good buying opportunities if the economy doesn’t go into recession,” observes Kostin.

Ratings

Investors have fourth-quarter earnings to digest for now, and with a third of them, 78% beat forecasts.

Overall, Fed officials are still showing their newfound zeal to tighten financial conditions rather than push back from current market prices. Equities simply hang on.

Another reason equity strategists hold the line may be that they simply disagree with their rate colleagues. Or, as Marko Kolanovic and his team at JP Morgan put it in a note on Monday, they think current rates market prices are too aggressive.

“Our economists are now forecasting five hikes in 2022, but we think the risk is that the inflation-related data will improve and fewer hikes will ultimately be made,” they said.

Now that would be bullish for stocks.

(Views expressed here are those of the author, columnist for Reuters.)

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By Jamie McGeever; Editing by Andrea Ricci

Our standards: The Thomson Reuters Trust Principles.