Stocks fell following Wednesday’s message from the Federal Reserve that interest rates will remain on hold for longer than investors thought.
The S&P 500 fell more than 2% in two days and the benchmark 10-year Treasury yield hit a 15-year high. Overall for the week, data from Bank of America showed investors dumped stocks at the fastest pace since December 2022.
But that reaction can be overblown, according to Tom Lee, head of research at Fundstrat.
“The market had an overly hawkish reaction to the FOMC meeting,” Lee said in a video to clients after the market closed on Thursday.
Lee disagrees with one of the main reasons for the market action. The Federal Reserve has updated Summary of economic forecasts (SEP) released on Wednesday showed a bias towards one more interest rate hike this year and the Fed now indicated that interest rates remain higher than expected in 2024 and 2025 by the central bank.
Lee, however, doesn’t see this as a major issue and says it has a higher value. It makes sense as the Fed raises its outlook for gross domestic product (GDP) for a consecutive period in the Fed’s forecast.
Fed Chairman Jerome Powell said during a press conference that economic growth – which the Fed expects to hit 2.1% this year, up from 1% in June – will be the driver of another rate hike, not inflation.
“In the last year, we have seen that inflation has been more persistent, but I would not say that this is something that has been seen in recent data,” Powell said. I would say it’s more about strong economic activity. So if I have to say one thing, again, here we choose the media and we are trying to give an explanation, but the broader strong economic activity means that we have to do more. Rates.”
For Lee, the marriage of higher interest rates and higher GDP not only makes sense, but could also mean higher rates of income as the economy expands. Higher P/Es can lead to higher stock prices.
“A hawkish take has increased the persistence of inflation and therefore the Fed funds rate should remain high,” Lee wrote in a note to clients on Friday.
But, as Lee noted, the Fed’s forecast does not predict an increase in inflation.
Lee also emphasizes that the forecasts themselves are just that – forecasts – and can often be changed by the feds. For example, just three months ago, the Fed predicted 0.5 percent more rate cuts in 2024 and 2025 than it did in its latest forecast released Wednesday. Despite the market reaction, Powell himself sent a similar warning about SEP in a press release.
“The SEP is not a negotiated or negotiated plan, it’s like a plan,” Powell said. “It’s actually gathering, and what you’re seeing is the media … so I don’t want to give the impression that it’s actually a plan. But what it does reflect is that economic activity is stronger than ours. It’s expected, it’s stronger than everyone expected.”
High prices on Treasury yields don’t worry Li too much either. On Friday, the yield on 10-year Treasury notes hovered around 4.4%. Lee said the average yield on 10-year Treasury notes is down 3.5% to 5.5%, while the average price-to-earnings ratio on the S&P 500 is about 20. They agree with the P/E starting in 2019, Lee, and it could go higher.
“I don’t think this increase in production is a thesis killer,” Lee said in the video. “Obviously, this is a headwind for stocks. I’d like to see the yield lower, but I think the selloff over the last couple of days is overblown.”
Lee’s final point focuses on the timeliness of the research note. September is a notoriously bad month for stocks. But Lee says an exit from “seasonal weakness” could be a tailwind for stocks. Ryan Detrick, chief market strategist at Carson Group, agrees with Lee.
When the last three times The S&P 500 fell more than 1 percent in both August and September, while the benchmark index rose at least 8 percent in October.
“As bad as things feel.” Detrick wrote on X “Don’t lose faith yet.”
Josh Shafer is a Yahoo Finance reporter.
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