US stocks could rally another 25% now that the Fed is no longer ‘back to the wall’ in the fight against inflation

One of Wall Street’s most relentless bulls has explained why he thinks US stocks can continue to rally through the end of the year after October’s game-changing inflation data on Thursday.

Tom Lee, head of research at Fundstrat, said in a note to clients dated Friday that while “inflationists” doubt October’s weaker-than-expected inflation reading could be repeated, Fundstrat sees three reasons for which the latest inflation report could represent a turning point in the Federal Reserve’s battle to suppress price pressures.

See also: US inflation has stopped boiling, but it will take much longer to cool down down

Those reasons included a “significant slowdown” in the consumer price index month-over-month, a “refund” of durable goods inflation and the contraction in the cost of health insurance.

Lee explained his reasoning:

  • “Housing finally showed a significant slowdown in MoM CPI, as OER (owners equivalent rent, >23% of CPI basket) slowed to +0.6% (+0.7%/+0, 8% Aug/Sept) and trending toward the reality of the housing deflation market.”

  • “Durable goods are finally showing a ‘boost’ return on investment as the CPI for durable goods fell to -0.7% MoM (-8.4% annualized) and even used cars finally showed some weakness down -2.4% for the month (but still 15% drop).”

  • “Medicare has massively swung to -4% MoM 12 consecutive months from +2.4% (since Oct 2021) and given the annual adjustment it is expected to drop 40% over the next 12 months .”

These are signs that inflation should “significantly slow” in the coming months, Lee said, adding that if all goes well, the U.S. economy could see “three to four months” of core CPI rise to a rate of 0.3% per month. month.

The pace of the so-called core inflation rate, which omits food and energy costs, slowed to 0.3% in October, below Wall Street expectations of a 0.5% increase.

The most important takeaway from October’s inflation data is that the Fed is no longer “back to the wall,” which could allow for a more substantial slowdown in the pace of interest rate hikes, Lee said. Ultimately, he noted, “the case for a break after December is stronger.”

Market analysts have been on the lookout for signs that the Fed may pause aggressive interest rate hikes or perhaps even move toward an interest rate cut, as there is widespread consensus on Wall Street that it would help end bear markets in stocks and bonds. This year.

The Fed has raised the federal funds rate, a key Wall Street benchmark rate, by 3.75 percentage points since the start of the year, including four consecutive “jumbo” hikes of 75 basis points, including one more early this month.

Even if the Fed keeps the rate above 5% for now, the move from “higher in a hurry” to “predictable but maybe longer” would be more sensitive to stock valuations, Lee said.

Fed funds rate traders expect the rate to peak at 5% in March and stay there until at least the fourth quarter of 2023, according to the CME’s FedWatch tool.

Slowing inflation could also help equities by avoiding a deep recession and increasing the odds that the Fed could guide the U.S. economy into a “soft landing,” Lee said.

Lee and his team said this latest rally could last up to 50 days and help the S&P 500 climb as much as 25% if investors accept the idea that the Fed’s worst rate hikes are over and the central bank will likely “pause” these hikes early next year.

Going forward, the S&P 500 should be able to break above its 200-day moving average of around 4,100. If investors receive another soft CPI report in December, the large-cap index could even hit the 4,400 range. at 4,500.

FUND STREET

Sometimes described as a “permabull”, Lee maintained his bullish outlook for stocks for most of the first half of 2022, but admitted in March that he had been “too optimistic” as he continued to argue why the Equity valuations looked attractive.

U.S. stock indices had their best session in more than two years on Thursday as the S&P 500 SPX,
+0.08%
rallied more than 5.5%, the Nasdaq COMP,
+52.06%
climbed nearly 7.4% and the Dow Jones Industrial Average DJIA,
-0.81%
advanced by more than 1,200 points. Shares are expected to open higher and add to those gains on Friday.

.

Leave a Comment

Your email address will not be published. Required fields are marked *