U.S. stocks have been unaffected by higher interest rates from the world's most powerful central bank over the past few years, as incremental earnings growth gives investors ample reasons to pour money into equities even amid an increasingly gloomy policy-rate outlook, according to DataTrek Research.
Corporate earnings growth matters more to stock prices than the Federal Reserve's interest-rate policy over the longer run, Nicholas Colas, co-founder of DataTrek Research, said Monday in a client note.
U.S. stocks have "entirely" ignored structurally higher Fed-funds rates since 2019 and moved almost exactly in line with corporate earnings power, said Colas. The yield on the 2-year Treasury note BX:TMUBMUSD02Y, a proxy for the market's expectations of the central bank's future monetary policy, has risen to 4.747% on Monday from around 1.6% at the end of 2019, while the S&P 500 index SPX has advanced 58% over the same period with its earnings up 46%, according to data compiled by DataTrek.
"Higher long-term rates have not hurt equity valuations one bit," Colas said, adding that even if the Fed does not start cutting interest rates this year, a stronger-than-expected U.S. economy can still deliver earnings growth and high stock prices.
So far this year, a slew of hotter-than-expected inflation reports has forced investors to reconsider expectations for the Fed's rate-cut outlook. The number of cuts has been dialed back aggressively in the interest-rate futures market over the past two months.
Fed-funds futures traders now price in three quarter-point cuts in 2024, starting from June - down from expectations of six or seven at the start of the year, starting from March or May, according to the CME FedWatch Tool.
However, the stock market hasn't seemed bothered. Last week, the S&P 500 closed at its 17th all-time high on Tuesday after the February CPI report, bringing the year-to-date return for the large-cap index to 8.1%. The Nasdaq Composite COMP gained 7.4% in 2024 so far, while the Dow Jones Industrial Average DJIA was up 3.1% over the same period, according to FactSet data.
U.S. stocks were also surging on Monday as investors looked ahead to Fed Chair Jerome Powell's remarks and an update to the Summary of Economic Projections at the end of the Federal Open Market Committee meeting on Wednesday afternoon.
The Nasdaq was jumping over 1%, while the Dow industrials were up 0.4% and the S&P 500 was rising 0.8% on Monday afternoon, according to FactSet data.
"Earnings growth is the most important driver of stock prices, with Fed policy a side show unless a recession starts to unfold," said Colas. He admitted that stocks may turn "wobbly" when Powell and the FOMC start talking about fewer rate cuts this year, but that is "not a sufficient reason to turn bearish [on stocks]."
Instead, a Fed hawkish pivot would be a sign that the economy remains reasonably strong, a good backdrop for improving corporate earnings in 2024 and 2025, Colas wrote on Monday.
The S&P 500 index is expected to post an 11.2% earning-per-share improvement in 2024. It is also forecast to report year-over-year earnings growth of 3.3% in the first quarter of 2024, said John Butters, senior earnings analyst at FactSet Research.
If 3.3% is the actual growth rate for the three-month period ending March 31, it will mark the third consecutive quarter of year-over-year earnings growth for the S&P 500, Butters said in a Friday note.