Traders work on the floor at the New York Stock Exchange.
Brendan McDermid | Reuters
With a potentially negative earnings season looming, investors see easy Fed policy as the security blanket the stock market needs as it breaks to new highs.
The thinking is that there is a ‘Fed put’ on the stock market, meaning with the Fed ready to cut interest rates, how much downside could there be for the market? But that question gets trickier with the stock market carving out new highs, and an upcoming earnings season that is forecast to see profits decline.
The Fed “is the factor,” said Michael Farr of Farr, Miller & Washington. “If you don’t have organic earnings growth and improving balance sheets, what else is going to drive prices?”
Fed Chair Jerome Powell’s dovish comments this week sparked a stock market rally Wednesday and part of Thursday, driving the three major indices to new highs. Stocks were off their highs Thursday afternoon, after indices briefly breached big round milestones. The S&P 500 rose above 3,000 for the first time ever Wednesday, and the Dow topped 27,000 Thursday. Many Wall Street analysts have their year end targets set around 3,000 or below, and the average target of analysts surveyed by CNBC is 2,950.
Economists widely expect the Fed to cut interest rates at its July meeting by at least 25 basis points, or a quarter point. The fed funds target rate range is currently 2.25% to 2.50%. Investors in the fed fund futures market are pricing in a little more than a full quarter point cut for July, but nearly three 25 basis point cuts by the end of the year.
“My thought is if rates don’t fall, stock prices will,” said Sam Stovall, chief investment strategist at CFRA. If the Fed does not take action to cut interest rates at at its next meeting, on July 31, Stovall said the market could head for a correction pretty quickly.
Stocks have been rising ahead of the Fed’s expected action, and history shows they could keep on rising once the Fed starts the rate-cutting cycle. Stovall said the S&P 500, since World War II, has risen 10.3% on average in the six months after the Fed starts cutting rates, and then 14% by the end of the first year.
Beyond the Fed, strategists said the stock market needs to see steady economic data and the trade war to be resolved between the U.S. and China to make a big leap forward.
“I think the market is trying to decipher now how many rate cuts and how much and whether the first one will be an important inoculation. Clearly the Fed sees the global slowdown coupled with uncertainty with the tariffs as a significant downside risk,” said Quincy Krosby, chief market strategist at Prudential Financial.
Net benefits to stocks from lower interest rates could be a weaker dollar, which would filter through as a positive to the earnings of S&P 500 companies with overseas sales. Highly indebted companies, including many smaller firms, would also see a lift from lower interest rates.
“If the Fed is here and the tariff issues are resolved, the markets can continue moving higher. There is no doubt there will be pullbacks. But nonetheless, the Fed will help…It will weaken the dollar. It will be helpful for all markets. It will be helpful for emerging markets. It will be helpful for the Chinese. And U.S. exporters,” said Krosby. “Right now for the market, if they’re going to lower rates and there’s no further deterioration in the economy, that is the best back drop for markets.”
But the roll out of corporate earnings next week could be a challenge.
Stovall said S&P 500 earnings are collectively expected to decline 1.7% for the second quarter, after rising 2.5% in the first quarter. Earnings are key to the way the market values stocks, and with the earnings season starting next week, bad news could come out not only in the second quarter reports but in forecasts. Companies could certainly be glum as they detail the impact of tariffs, global weakness and even dollar strength on their bottom lines.