Easing inflation and potential rate cuts by the Federal Reserve may provide a much-needed boost to the underperforming segments of the U.S. stock market, according to Craig Sterling, Head of Equity Research, U.S. at Amundi’s Investment Institute.
Last year, a select group of large-cap technology stocks dubbed the “Magnificent Seven” saw an impressive average gain of 111%, while the remaining companies in the S&P 500 index only advanced by approximately 3.5%, Sterling revealed during a recent company outlook.
The “Magnificent Seven,” consisting of Apple Inc., Alphabet Inc., Amazon.com Inc., Meta Platforms, Microsoft Corp, Nvidia Corp., and Tesla Inc., have maintained their upward trajectory in January, despite some internal divisions within the group.
Sterling believes that strategically investing in “the rest” of the S&P 500 could be beneficial in 2024. Amundi holds the view that the Federal Reserve is unlikely to implement as many rate cuts as anticipated, and a sustainable earnings recovery may not materialize until the second half of this year. Such developments could potentially ignite a broader stock-market rally.
The Impact of Interest Rates on Earnings
In a recent statement, Sterling, an industry expert, emphasized the importance of considering interest rates when evaluating stock investments. He expressed caution towards stocks trading at high price-to-earnings ratios. Specifically, he mentioned the Magnificent Seven stocks, which have higher forward price-to-earnings ratios compared to the rest of the S&P 500.
Sterling further highlighted the concerns surrounding excess liquidity in the financial system. He pointed out that the Federal Reserve’s plan to let its emergency bank-lending program expire could lead to a drain in liquidity. This program was initially introduced after the collapse of Silicon Valley Bank to mitigate a potential banking crisis.
On a positive note, there has been stability in the Treasury market, with longer-duration bonds becoming more appealing. Paresh Upadhyaya, the director of fixed-income and currency strategies at Amundi, noted that the recent stability in the approximately $26 trillion Treasury market makes it an attractive option. Despite reaching a 16-year high of 5% in October, the benchmark 10-year Treasury yield has since dropped to around 4% in December and has remained relatively stable at around 4.2% in recent weeks.
Upadhyaya believes that including longer-duration bonds in one’s investment portfolio is a wise decision. Referring to it as a “no-brainer,” he suggests that this move provides a valuable opportunity for investors.
While recent market performance has been positive, with the S&P 500 reaching a fresh record and the Nasdaq Composite Index gaining ground, caution remains regarding the potential impact of interest rates on earnings. Evaluating forward price-to-earnings ratios and considering the stability in the Treasury market can help investors navigate these uncertain times.