While the Fed believes it can achieve this reduction without disrupting the equity markets or causing an economic contraction, history suggests otherwise. As Michael Hartnett from BofA noted:
"S&P500 companies generated $220 of EPS per 12 months; applying a 20th century PE of roughly 15x gets you to an S&P500 index of 3300, applying a 21st century PE of 20x gets you to an S&P500 of 4400; there's your range.
We say drivers of high 21st century PE all reversing. From QE to fiscal austerity, free movement of trade, people, capital, geopolitical peace there is a new regime of higher inflation. Such means the secular view remains cash, commodities, volatility to outperform bonds & stocks, It also means inflation in things we don't have enough of such as energy, workers, places to rent, food, raw materials, good infrastructure, and military equipment. The deflation will be in things we have too much of from government debt, office space, mobile phones and streaming content."
He further notes the recent rally was in line with historical bear market rallies.
"The average S&P gain in 43 bear market rallies since 1929 was 17.2%, with an average duration of 39 trading days. The current rally was 17.4% in 41 days, or as Hartnett puts it, textbook. Furthermore, bear-market rallies are always "narrow." The recent rally was also narrow 30% of the entire gain in the S&P 500 coming from just 4 stocks: AAPL, MSFT, AMZN, and TSLA.
To Hartnett's point, the Fed's focus on combatting inflation, which means slowing economic growth, removes the drivers of the previous bull market. As the Fed noted:
"Once the policy rate had reached a sufficiently restrictive level, it likely would be appropriate to maintain that level for some time to ensure that inflation was firmly on a path back to 2%".
Nowhere in that statement is a notion of cut rates anytime soon, which belies those jumping into stocks hoping for a "pivot."
Lance Roberts
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