Did Powell Just Fuel the Stock Market’s Surge?

Jerome Powell’s recent address at the Jackson Hole symposium has sparked notable reactions in financial markets, with many analysts perceiving his dovish tone as a catalyst for potential gains in an already bullish stock market.

The Federal Reserve Chair’s comments appeared to validate widespread anticipations of an imminent rate cut, which could have significant impacts on equities and the broader economy. Analysts at Yardeni Research interpreted Powell’s speech as clearly supportive of the stock market, indicating that the expectations for a September interest rate reduction are almost assured, with the possibility of several more cuts to come.

This sentiment aligns with market expectations, which are factoring in multiple rate reductions as the Fed seeks to handle decreasing inflation while avoiding a recession. Investors viewed Powell’s statements as a signal for continued market growth, particularly benefiting sectors sensitive to interest rates.

Lower interest rates typically uplift stock prices as they reduce borrowing costs, increase potential corporate profits, and enhance the appeal of equities over fixed-income investments. However, there is a prevailing sentiment that much of the anticipated rate cuts may already be accounted for in current stock prices.

Analysts expressed that upcoming economic data could surpass expectations, potentially tempering forecasts for rate cuts. Despite these concerns, Yardeni Research maintains an optimistic perspective, adhering to their “Roaring 2020s” scenario, which suggests a 60% probability that the stock market could reach various targets: 5,800 by the end of this year, 6,300 by the end of next year, and 6,825 by the close of 2026. This outlook is supported by projected earnings growth and a forward price-to-earnings (P/E) ratio of 21.

The concept of a stock market “melt-up,” characterized by rapid and unsustainable increases in asset prices, has also captured attention, with Yardeni Research assigning a 20% likelihood to this happening, potentially increasing these odds in light of Powell’s remarks.

Notably, there is an unprecedented $6.2 trillion in money market mutual funds—comprising $2.5 trillion in retail fund investments—that could rapidly shift into equities if money market yields soften due to rate cuts. Signs of this shift are already evident, particularly with increased investment in riskier assets like small-cap stocks.

Additionally, the yield curve has been experiencing a disinversion, with the gap between the 10-year and 2-year US Treasury notes narrowing to -9 basis points. Traditionally, such a disinverted yield curve has foreshadowed recessions and bear markets; however, Yardeni Research suggests that this cycle may differ, as the Fed is proactively lowering rates in response to declining inflation rather than an imminent financial crisis.

Despite the positive outlook for the stock market, geopolitical risks and inflation worries remain pertinent. Yardeni Research continues to attach a 20% probability to a scenario reminiscent of the 1970s, potentially intensified by escalating geopolitical tensions. Recent military conflicts, such as those between Israel and Hezbollah, have raised fears of disruption in global oil supplies, causing energy prices to spike after Powell’s address. Increased energy costs could reignite inflation fears, complicating the Fed’s efforts to balance economic growth with price stability and posing risks to current market optimism.

Regarding insider activities, Yardeni Research noted that insider buying has decreased as the market rebounded from early August’s sell-off. Nonetheless, significant purchases were observed in the energy sector, particularly by companies involved in US and energy services, alongside actionable investments in technology, high-dividend business development firms, and retail sectors, spanning physical stores, online entertainment, cosmetics, and travel-related businesses.