A Second-Half Stock-Market Rally Is Still in Play Despite Rout

Stock-market believers are looking past the roughest stretch in months for US equities and clinging to bets on a rally in the back half of the year once the Federal Reserve stops hiking interest rates.

The S&P 500 Index is coming off its worst week since Dec. 9, as hotter-than-forecast inflation data boosted speculation that the Fed will lift borrowing costs several more times, potentially pausing in July. That’s a steeper path of policy tightening than investors were bracing for just a few weeks ago.

However, it still largely tracks with the theory that’s prevailed since the end of 2022: That equities would struggle through the first six months of the year before gaining strength in the second half. Stock-market technicals indicate that investors agree with this logic, as the S&P 500’s uptrend that started last fall continues even with the index losing 2.6% this month.

“We’re getting closer to the end of the Fed’s rate cycle and markets will begin to start discounting that,” said Mary Ann Bartels, chief investment strategist at Sanctuary Wealth.

Of course, risks to this outlook abound. Swaps traders see a peak rate of roughly 5.4% in July, up from around 5% at the start of February. But a new paper argues that it may need to rise as high as 6.5%, raising the specter of a so-called hard landing in which the economy falls into a recession. In the rosier soft-landing scenario, the Fed tames inflation while the economy continues to grow.

“The market can handle a terminal rate at 5.5%, but it wouldn’t be able to handle one that’s 6% or higher,” Bartels said “That would really rock markets.”

The alarming inflation figures weren’t the only trigger for the S&P 500’s down week. Dire forecasts from bellwethers like Walmart Inc. and Home Depot Inc. also soured the mood. This week brings more clues on the health of the consumer, with profit updates from Target Corp. and Lowe’s Cos.