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EconomyStocks surge on optimism as US inflation cools, but potential risks loom

Stocks surge on optimism as US inflation cools, but potential risks loom

In the midst of decreasing U.S. inflation, the stock market is experiencing a wave of optimism. Over the past week, the S&P 500 surpassed 4,500 points for the first time in over 15 months, driven by data revealing lower-than-expected inflation in June from both the consumer price index and the producer price index.

Many bullish investors anticipate an improved economic outlook that could propel the S&P 500 to reach an all-time high later this year. The index’s record close of 4,796.56 in January 2022, according to Dow Jones market data, reported by Market Watch, is within their sights.

Scott Ladner, Chief Investment Officer at Horizon Investments, aligns himself with this positive outlook. In a phone interview, Ladner stated, “This is increasingly looking like an economy that just can’t be knocked off its feet.” He further highlighted the potential for nominal GDP to range between 5% and 7% this year, with earnings currently undervalued. Ladner believes there is room for earnings to catch up and propel the market even further.

Furthermore, the Federal Reserve’s campaign to raise interest rates to curb inflation and stabilize borrowing costs may be nearing its end, potentially adding fuel to the stock market rally. Ladner noted that market consensus predicts at least one more interest rate hike by the end of the year. Future funds traders are pricing in a more than 95% chance of a 25-basis point interest rate increase in July, with a 23% probability of an additional hike thereafter, according to CME Fed Watch.

Ladner emphasized the possibility that interest rates may have already peaked, which could contribute to an expansion in stock market multiples. Greg Bassuk, CEO of AXS Investments, echoed this sentiment, suggesting that the end of a two-year period of rate hikes could bring certainty to the market and facilitate a soft landing for the U.S. economy, potentially avoiding a recession.

Additionally, the weakening U.S. dollar is providing a tailwind for risky assets. The ICE U.S. Dollar Index dropped to its lowest close since April 2022, according to Dow Jones market data. Ladner pointed out that if the Fed concludes its rate hikes while other central banks continue to raise rates, it could further weigh down the U.S. dollar.

Despite the prevailing optimism, there are several challenges that could impede the stock market’s extended rally. Raymond Bridges, Portfolio Manager of the Bridges Capital Tactical ETF, anticipates a decline in U.S. stocks by the end of the year due to further tightening of credit conditions. As the Fed’s balance sheet shrinks to pre-March levels, banks that received emergency loans may have to repay them, resulting in a net liquidity draw that could impact the stock market’s upward trend.

Furthermore, if the Fed implements additional interest rate hikes after July, it could significantly undermine the U.S. economy. The Fed’s dot-plot forecast from June indicated officials’ expectation of two more rate hikes by year-end. Philip Colmar, Managing Partner and Global Strategist at MRB Partners, cautioned that although credit conditions may not be tight enough to trigger a recession this year, further rate hikes or a meaningful increase in yields could become catalysts for a downturn.

Analysts at Capital Economics adopt a more bearish stance, asserting that the U.S. economy is already heading toward a mild recession. While acknowledging the transformative potential of artificial intelligence (AI) in bolstering the stock market in 2024 and 2025, they maintain their forecast that the S&P 500 will experience a modest decline in the second half of 2023 as the U.S. economy temporarily weakens.

Although many analysts anticipate a continued decline in inflation, unexpected price increases in certain months could pose challenges, according to AXS Investments’ Bassuk. Factors contributing to the consumer price index and producer price index can vary, and even slight changes can influence their outcomes.

Closing the past week on a positive note, U.S. stocks experienced gains, with the Dow Jones Industrial Average rising by 2.3%. The S&P 500 gained 2.4%, while the Nasdaq Composite closed the week 3.3% higher. This was published by CNBC.

In the upcoming week, investors will closely monitor U.S. retail sales data on Tuesday, housing starts numbers on Wednesday, and initial jobless claims data on Thursday, seeking further insights into the state of the economy.

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