Stocks have seen significant gains amid a prolonged period without Federal Reserve interest rate changes, prompting investors to look to corporate earnings for a potential second-half rally.
In early April, concerns about persistent inflation and a strong job market led to a slight pullback in the S&P 500’s year-to-date gains. However, the index has since recovered most of those losses, rising by over 3% in May and extending its year-to-date advance to 8.8%.
Recent gains have been largely driven by better-than-expected corporate earnings, particularly from major tech companies known as the “Magnificent 7”. Additionally, assurances from Fed Chairman Jerome Powell that rate hikes are not imminent have contributed to a decline in Treasury bond yields.
With approximately 80% of S&P 500 companies reporting earnings for the March quarter, profits are expected to increase by 7.1% compared to the previous year. Looking ahead, earnings for the June quarter are forecasted to grow by 11.1%.
The April jobs report, which showed steady hiring momentum but without significant wage pressures, has also supported market sentiment. As a result, benchmark 10-year Treasury yields have declined from their late-April peak, alleviating some downward pressure on markets.
Market observers note that the Fed’s current stance, coupled with uncertainty in the macroeconomic environment, makes it challenging to predict future market movements solely based on policy signals. Traders now anticipate the first rate cut of 2024 to occur in September, which would mark a substantial gap since the previous rate hike in July 2023.
Historically, long pauses in Fed policy have been favorable for stocks, with certain sectors like financials and energy outperforming during such periods. While monetary policy is an important factor, other fundamentals such as economic conditions, earnings, and valuations also influence market performance.
Some analysts caution that current market gains may be driven more by fear of missing out than by underlying fundamentals. With no rate cuts expected until later in the year and the next earnings season still months away, market catalysts are limited, leaving investors to focus on valuations and quality.
Although stock valuations appear rich compared to historical averages, strong earnings support and neutral long-term bond yields provide some comfort to investors. Despite the challenges posed by high interest rates and elevated expectations, solid corporate earnings continue to buoy market sentiment.
