The S&P 500 has staged an extraordinary rally since stimulus measures were implemented in the wake of the outbreak of the Covid-19 pandemic in early 2020. At a time of a severe economic slowdown, the stock market has seen record highs. This is attributed to the fiscal and monetary policy responses.
It is well documented that the Federal Reserve has reversed its policy and is now beginning to tighten. The degree and velocity of which is up for debate, but it has been made clear that this is now the path of the central bank. The then-dovish members of the Federal Open Market Committee (FOMC) appear to have recognized that the need to fight inflation is now upon them.
The latest annual US data shows GDP growth at 7.0%, headline CPI at 7.9%, PPI at 10.0% and the unemployment rate under 4%.
Interest rate movements impact an equity valuation in many ways. Most pertinently, by the change in the cost of capital and the rate at which future cash flows are discounted. Companies that offer dividends also gain or lose on changes in rates as they become more, or less attractive investment alternatives.
Going into the end of the first quarter, the recent uptick in hawkishness from the Fed has seen equity prices rally, somewhat counterintuitively. The market appears to be looking at companies and believing that they will be able to pass on higher input costs. The higher that equity prices go under these assumptions, the further behind the curve the Fed falls.
In this scenario, the Fed could be forced to amplify its effort to rein in prices or alternatively, companies experience margin compression. The latter would seem less likely. Unless the prices of stocks fall, this feedback loop from equity markets may force the Fed’s hand for more aggressive tightening
S&P 500 Daily Chart
Chart prepared by Dan McCarthy, created with TradingView
Looking at the chart, the all-time high is at 4808 and a move above there could signal that further upside is possible. A failure to make a new high may see a bear market unfold in the medium-term.
The recent high of 4586 may offer resistance.
