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Written by: Kevin McCreadie, CFA®, MBA | AGF
What is driving global equity markets to new all-time highs after hitting a rough patch in April?
The current leg higher is being fueled mostly by the belief that the U.S. Federal Reserve (Fed) is finally done hiking rates and slowly inching towards a rate cut later this year. Granted, investors should know by now that’s hardly a guarantee. Nor does it sound like much of a catalyst given what expectations used to be just a short few months ago. In fact, if you recall, many forecasters – but not us – had assumed the Fed was getting set to cut six or seven times this year and was well past the point of needing to raise rates again. Yet, that expectation has not become reality – not even close. And while global equity markets continued to rally early on as investors adjusted to the fact of the Fed taking a less accommodative stance than anticipated, there was a limit to how much they were willing to accept.
More specifically, the pullback in April was precipitated by fresh fears the Fed would end up not cutting rates this year and would even be forced to raise rates in another attempt to quell the country’s stubborn inflation rate, which had ticked up two months in a row (February and March) to a level higher than it was at the end of last year.
In response, Fed Chairman Jerome Powell downplayed the possibility of more rate hikes, saying in his press conference following the Federal Open Market Committee’s (FOMC) latest decision in early May that such an outcome was “highly unlikely.” In turn, that eased some of the fears being felt by investors and helped reignite the rally in global equity markets, which, by then, was already beginning to gain renewed steam.
Still, the icing on the cake, so to speak, was the release earlier this month of April’s global inflation rate dropping to 3.4% from 3.5% previously. This was followed by much weaker retail sales data, which implies a consumer slowdown that could stem a further push higher in prices. Combined, this not only gave more credence to Powell’s statement about rate hikes being unlikely at this juncture in the cycle but has also reignited the chance of at least one potential rate cut – if not more – before 2024 draws to a close.
So, while investors aren’t getting what they originally expected of the Fed – and have struggled at times reconciling this reality – we believe they now seem largely content with what’s more realistically ahead of them. Indeed, even the recent release of the FOMC’s minutes from May, which show some Fed participants are willing “to tighten policy should further risks to inflation materialize” hasn’t stopped benchmarks like the S&P 500 Index from continuing their upward trajectory.
Are there other factors that are allowing investors to still view Fed policy as a “glass half full” proposition for equity markets?
It’s not like investors have just stayed the course. As mentioned, there was the pullback in April and the breadth of market returns since then has diminished, much like it did during long stretches of last year when market-cap weighted indexes performed significantly better than equal-weighted ones. And we believe this crowding effect may continue until there’s greater assurance about rate cuts and the economy at large. After all, in this environment, investors generally feel more comfortable investing in names that are more resilient to swings in economic activity than they are in sectors or stocks that tend to benefit more in periods of economic strength and certainty.
Of course, having said that, there’s no question that another season of solid earnings results has helped fortify the new leg in the rally. As of last week, 78% of S&P 500 companies have reported earnings per share above estimates, which is higher than both the five-year average of 77% and the 10-year average of 74%, according to Factset data. In addition, companies have reported earnings that are 7.5% above estimates, which is below the five-year average, but above the 10-year average of 6.7%.
Beyond that, it shouldn’t be understated how powerful rallying markets are in and of themselves in terms of creating upward momentum in stock prices. Retail investor participation, in particular, has increased dramatically in recent weeks, suggesting these types of investors are feeling more confident about the prospects of global equities – especially given how auspicious returns have been since the end of October and “the fear of missing out” feeling that may be creating.
Ultimately, there may not be as clear a path forward for investors as the current rally suggests. All it might take for the market to start wobbling again is for inflation to tick up or not fall fast enough. Or for there to be a release of another economic data point that puts in question the idea that the Fed is done hiking rates and ready to cut some time this year. And that’s true not just in the United States, but in other countries like Canada as well, where a rate cut may be closer at hand, but still largely dependent on inflation continuing to move lower.
Moreover, investors can’t lose sight of some of the ongoing geopolitical risks that are at play or the U.S. election in November, which has the potential to roil markets and impact Fed policy all on its own.
At best, then, we believe global equity markets still have the potential to move higher from here, but not likely without interruption or at the same torrid pace as the past six months.
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