The Fed is Sparking a Rally - Is This Just the Beginning?

The Fed is Sparking a Rally — Is This Just the Beginning?

US Federal Reserve officials have hinted that they will only cut interest rates once this year. Updated forecasts on 12 June Wednesday revealed that the Fed’s median rate-setter anticipates a 0.25% cut this year (the central bank currently holds rates at 5.25% to 5.50%), surprising traders who had expected two cuts before the report was released. Nevertheless, this helped the S&P 500 index reach a new all-time high above 5400, and it could still be just the beginning of the future rally.

For example, On June 17, 2024, Goldman Sachs raised the baseline year-end target for the S&P 500 index to 5600, implying almost 4% upside for the overall market. It’s rational to expect more optimism to come from analysts as recently even one of Wall Street’s last remaining bears, strategist Michael Wilson from Morgan Stanley, has finally capitulated and has set a 5400 target for the S&P 500 index up from his old gloomy outlook of the 4500.

Of course, the basis for such optimistic consensus is that the potential easing of monetary conditions could be a positive catalyst for the overall US economy and corporate profits, which are both currently robust. However, this expected decrease in interest rates could also motivate investors to move from short-term money market instruments and deposits into riskier assets like stocks and bonds.

According to Bank of America, US households will start buying stocks as soon as rates begin to fall — as they have done before. This would create significant demand for stocks. After the pandemic started, the peak 2-year flow into equities from households was over $10 trillion (or almost 30% of the total US market capitalization at that time). A similar trend could be expected to repeat soon as funds will transfer from the money market to the financial market.

Currently, American households are already the largest stockholders, directly owning about 40% of the US market. It should be noted that the next biggest force is international investors, who hold around 20% of the total US stock market. So, the behavior of households significantly influences stock price dynamics (we could also have seen that from the GameStop case).

The size of the money market has now exceeded an enormous $6 trillion, primarily driven by retail investors thanks to surplus savings and the shift from deposits. Market estimates suggest that between $500 billion and $1 trillion could flow from the money market to the financial market, predominantly into stocks.

Additionally, strong demand for stocks comes from corporations themselves via M&A activities and buybacks. Goldman Sachs predicts that this year companies can repurchase stocks of at least $550 billion.

Furthermore, on reflection, the stock market has finally come back to where it started in the hiking cycle. The S&P 500 Index is up about 13% from its highs that it achieved in the beginning of this year. It is almost identical for MSCI All Country World Ex-US Index that still has not returned to its previous high which allows a possibility for further advances.

These two significant demand forces could bring at least $1 trillion of total value into stocks as strong support for risky assets together with potential rate cuts near future. Thus, only a “black swan” event might end the current rally rather than any big shifts in fundamentals making investors apprehensive.

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The Fed is Sparking a Rally - Is This Just the Beginning?

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