Written by:  Mutsumi Kagawa (Chief Global Strategist, Economic Research Institute of Rakuten Securities)

(16/06/2023)

1. S&P500 rose more than 20% from its October low.

The S&P 500 index rose, affirming the “bull market” as it increased more than 20% from the low on October 12. In other words, it suggests that the bear market that started in January 2022 is over. The S&P 500 has recovered more than half from the range that fell between January to October last year, and this recovery reminds us of the market saying, “half-price return is full price return.” As of June 14, the S&P500 was 4379.59, up 13.9% since the beginning of the year. The rise of big tech stocks following the AI (artificial intelligence) boom led the rise, and the Nasdaq 100 index rose by +37.2%, which is a tailwind. In June, the debt ceiling crisis will come to an end, and the US economy is expecting a soft landing. On the other hand, the outlook that the FRB (Federal Reserve Board) is approaching the end of the rate hike cycle along with slowing inflation has been a positive factor. Investor buying interest is picking up.  The “bullish ratio” (percentage of investors expecting stock prices to rise) which the AAII (American Association of Individual Investors) publishes every week, has risen to 44.5%, the highest level since November 2021. Year-on-year growth of both the CPI (Consumer Price Index) and PPI (Producer Price Index) announced this week slowed down for the 11th consecutive month. The FOMC (Federal Open Market Committee) decided to “halt interest rate hikes” as expected by most. The S&P 500 is expected to continue to recover with the 200-week moving average line as support (lower support line) while making appropriate corrections (Chart 1).

2. Rule of thumb of “peak out of policy interest rate is a factor for high stock prices.”

The FRB decided to halt interest rate hikes at the FOMC held on June 13 and 14. The latest published SEP (Summary of Economic Projections) and FRB Chairman Powell’s press conference were somehow hawkish. So, we cannot say for sure that the interest rate hike is over. The market is also expecting further interest rate hikes in July and/or September. However, assuming that the rate hike cycle from March last year is nearing its peak (terminal rate), stocks are likely to recover in the second half of the year and next year. In fact, the S&P 500 performed relatively well after past rate hikes. Chart 2 shows the “S&P 500’s 1-year growth starting from the last day of rate hikes” and its average growth (+15.9%) for the 7 policy interest rate cycles since 1980.  Only 1 (May 2000) out of the 7 growths after 1 year was negative (the stock price fell). All the remaining 6 times recorded positive double-digit growth. For example, the final day of the last policy rate cycle hike was December 19, 2018, and the S&P 500 rose 27.9% through December 19, 2019. These are market performances and do not guarantee future returns, but they do show the trend that the stock market has generally favoured for the “stop rate hikes” scenario. The futures market expects the policy rate to peak in July or September, followed by moderate rate cuts by the end of the year. It means that the FRB is considering a “pivot” (policy change) in monetary policy depending on whether inflation continues to slow down, or the economy slows down. Assuming that sooner or later the market will be aware that the FRB will stop raising interest rates, I believe that the stocks may continue to recover while absorbing the temporary correction.

3. The market is aware of shifting to profit growth next year after this year’s decline

While the S&P 500 year-to-date growth reached +13.9% (June 14), you can see a difference between good and bad when looking at the growth by sector in the “11 major industry stock indices” shown in Chart 3. The three best-performing sectors since the beginning of the year are “IT (information technology)”, “communication services” and “consumer goods & services”. These are the only 3 sectors that have outperformed the market average (S&P 500) year-to-date growth. Looking at the performance outlook (average market forecast) of the IT sector, although earnings are expected to decline by 5.7% in 2023, it is expected to recover to double-digit growth (profit growth) in 2024 and 2025. Both communication services and general consumer goods & services are expected to continue push earnings in 2024 and 2025 following 2023. On the other hand, due to the slump in the resource until now, the energy business is expected to inevitably experience continuous declines in earnings in 2023, 2024 and 2025. “Real estate” is likely to significantly decline (-48.3%) in 2023 due to the cumulative effect of the interest rate hike from March last year and the impact of financial instability, but the performance is expected to recover after 2024. This can be a reference for sector (industry) diversified investment with a view to the performance outlook. Looking at the S&P 500-based performance outlook shown at the bottom of Chart 3, earnings are expected to decline (-2.3%) in 2023 but are expected to turn to an upward trend in 2024 and 2025. Considering the characteristics that “the stock market anticipates the fundamentals 6 months to 1 year ahead”, the market in the second half of this year (2023) may move with an awareness of the “turnover to profit growth in 2024”. When stocks fall in the short term, I would like to “buy on decline” and “bargain hunt” from a medium- to long-term perspective.

Name: Mutsumi Kagawa
Title: Chief Global Strategist
Organization: Rakuten Securities Economic Research Institute
Bio: Mutsumi Kagawa has an extensive background in the field of finance. In 1989, he began his career as a fund manager and investment researcher at various institutions, including Nikko Securities Investment Trust (Nikko Asset Management), Citibank, and Tokai Tokyo Research Center. With his experience working in the United States, Kagawa brings a global perspective that is highly regarded in his current role as the Chief Global Strategist at the Rakuten Securities Economic Research Institute.