Stocks may actually like an inflation-fighting Federal Reserve, despite weeks of nervousness and volatility leading up to the central bank's first interest rate hike in more than three years. Since the Fed raised its target fed fund rate range by a quarter-point March 16, stocks have mostly rallied through Tuesday's close. In the week since the rate hike, the S & P 500 is up about 2.2%. On Wednesday, however, the S & P 500 took a breather, closing 1.2% lower as oil prices jumped more than 5%. "The market believes that inflation is not going to evaporate, but it's going to get better," said Jonathan Golub, chief U.S. equity strategist at Credit Suisse. He said he is skeptical how much inflation can actually come down, but the market sees the Fed raising rates as a sign the central bank is on the job. Inflation is at a 40-year high, with February's consumer price index up 7.9% and March's reading possibly even hotter. "The market is soothed by the belief the Fed is engaged in the game," Golub said. "I believe that the Fed starting from zero interest rates and now 25 basis points has so much work to do in order to push back on inflation and that the economy is going to run hot for a decent amount of time, clearly through the end of the year," he added. "That is going to be surprisingly good for companies, good for corporate profits." Further leverage for raising rates? If the stock market can continue to hold its own, bond market pros say that will mean financial conditions are not stressed. That would give the Fed even more leverage to raise interest rates. The Fed forecast six more rate hikes for this year and three for next year when it released its new economic projections last week. But on top of that, Federal Reserve Chair Jerome Powell told an economists' conference Monday that the central bank could raise rates more aggressively if it needed to. Interest rates jumped, and the fed funds futures market moved to price in half point rate hikes for May and June. The 10-year Treasury yield reached a high of 2.41% Wednesday before falling back to about 2.3%. "The stock market to me seems comfortable… with six to seven rate hikes this year," said Scott Wren, senior global equity strategist for Wells Fargo Investment Institute. "I don't think the market is buying or not buying that we're going to have 11 rate hikes by the end of next year," Wren added. "The market is buying that inflation is going down. I don't believe the market believes that inflation is entrenched." Wren said during the last six interest rate hiking cycles, the S & P 500 was higher within a year of the first rate hike. In the last four cycles, technology stocks were the best performers during the entire cycle, he added. Proceeding with caution Ed Keon, chief investment strategist at PGIM Quantitative Solutions, said there are too many unknowns that are making it hard to be very bullish. He said he is slightly above benchmark weight in equities but still cautious. "We're just slightly overweight stocks. I don't want to make too big a bet on stocks because I think there's a lot that can go wrong," Keon said. "Obviously, we don't know what's going to happen with the war in Ukraine, and we do have a Fed tightening cycle that's begun and the record indicates it's hard to engineer a soft landing," he added. "Most of the time we end the hiking cycle in recession." Keon said the rate hikes are helping financial stocks, and the rally in oil is driving energy stocks higher. "It's still an environment that favors value, but you still do have the compelling long-term growth story in parts of technology," he said. "We're tilted toward value, but I think this is going to be a much more balanced year than the last few years where you had growth crush value." The Technology Select Sector SPDR Fund is up more than 2% since the Fed hiked rates, though it was down over 1% Wednesday. The Financial Select Sector SPDR Fund has gained about 0.7% since March 16. "For me, the the market is hanging in here pretty well given what's going on. We were down 10%, just given what the Fed was going to do," said Wells Fargo's Wren, adding the S & P 500 fell even more on the Russian invasion of Ukraine. Like others, he lowered his S & P 500 target after the invasion, which has sparked even more inflation. Wren said he cut his year-end target on the S & P to 4,800 from 5,200. He recommends technology and communications services, both areas that can grow earnings. Some strategists have been wary of tech and growth, since they can be adversely affected as rates rise. Those sectors trade on their future profits, and they can be pricey. Therefore, they do better in a period of easy money. Many in the space have corrected 50% or more. "I think cyclical companies... are going to do better," said Credit Suisse's Golub. He currently is neutral on technology. "I've been bullish on tech for over a decade," Golub added. "I'm such a long-term bull on tech, and the companies are such superior companies I would not recommend underweighting them. Now is not the time they are shining the most brightly, but it doesn't mean I don't like them." Cyclical companies include the stocks in the S & P energy, materials and industrials sectors. Energy is represented by the Energy Select Sector SPDR Fund ETF, and the S & P materials sector is represented in the Materials Select Sector SPDR Fund . "In the face of this, tech is showing resilience," said Scott Redler, chief strategic officer with T3Live.com. Redler, who follows short-term technicals, said some names should do better than others. He pointed to Tesla, Apple, Amazon, Microsoft and Alphabet. " Those names are still high-quality names that will probably make new highs in the next six to 12 months," he said.
U.S. Federal Reserve Chairman Jerome Powell testifies during the Senate Banking Committee hearing titled "The Semiannual Monetary Policy Report to the Congress", in Washington, U.S., March 3, 2022.
Tom Williams | Reuters
Stocks may actually like an inflation-fighting Federal Reserve, despite weeks of nervousness and volatility leading up to the central bank's first interest rate hike in more than three years.