When the Fed wrapped up its most recent meeting they announced another quarter point interest rate hike and the markets barely blinked. Markets have been on a tear and the rate rise did not deter them. Also, the tone coming from the Fed was much more accommodative than it has been over the last year. A lot has changed in that timeframe even since just six months ago when recession fears were peaking and major stocks like Google and Facebook were in freefall. Fed chairman Powell stated they would be “data dependent” regarding whether to raise rates again.
Over the past year and a half, the Fed has been at war with inflation. Raising interest rates has been their key weapon. The war is now essentially over as the current inflation rate is 2.97%, compared to 4.05% last month and 9.06% last year. Nevertheless, the Fed does not want to take their foot off the brakes just yet and cause inflation to pick up speed again. Also, the economy is showing that it is healthy enough to withstand higher rates for longer. Lending has picked up relative to a month ago, commodity prices are higher, and home prices are ticking up. It’s likely that the Fed won’t ease up on rates until these prices fall and job losses mount.
An economy with steadying or even decreasing rates should be good for stocks, but this new normal might be already priced into the larger players. In the second half of last year almost every sector of the market was already on an uptrend except for large-cap growth (AAPL, GOOG, MSFT, META, etc). Then in January we got a regime change and money rotated into these mega companies and out of most everything else. Many of these stocks made huge gains, but now it may be time for another regime change where a different sector or market cap (company size) takes the lead. The Nasdaq and S&P are both pushing up against the recent highs of last October where they ran into resistance and then fell until January. If technology is not participating in the upside during the second half of this year, then the overall markets are going to have a tough time as well. This does not mean there is no money to be made in this market, however. Industrials are already making new all-time highs, and we are seeing strength in the small and mid-cap space as well, as companies with market capitalizations below $10 billion play catch-up.
From a purely valuation perspective, stocks still look more attractive than bonds and non-tech stocks (like industrials, banks, and energy) look undervalued relative to their technology counterparts. At the end of the day, it’s all going to come down to the dollar. If the dollar is still falling in value, then stocks have room to run higher. And a more accommodative Fed should keep this trend on track. A cheaper dollar means higher profits for US multinational companies as they have pricing power over competitors. Over the next several months which regime will reign supreme? Tech has strong tailwinds, but we are keeping a watchful eye on other pockets of value.