According to DataTrek Research, U.S. equities are overvalued, given the uncertainty surrounding policy rates and the possibility of a recession. This view is due to the cautious approach U.S. financial markets are taking after Federal Reserve Chair Jerome Powell’s recent testimony before Congress. Powell indicated that policymakers would likely need to raise interest rates more than initially expected in response to strong economic data.
The market’s caution is reflected in traders’ forecasts of future interest-rate decisions. For example, on the second day of Powell’s testimony, traders of Fed-funds futures estimated a 76% chance of a half-percentage-point hike in interest rates at the central bank’s March 21-22 policy meeting, as per the CME FedWatch tool.
In contrast, just two days earlier, traders had only estimated a 31% chance of such a hike, and a month ago, the chances were a mere 3.3%. At the same time, the chances of only a 25-basis-point increase have decreased from 69% to 24%.
Although the central bank had previously raised rates by 25 basis points in February, marking a step down from previous rate increases, which included four consecutive 75-basis-point hikes and one 50-basis-point advance in 2022, Nicholas Colas, the co-founder of DataTrek Research, believes that the Federal Open Market Committee’s decision to downshift to a 25 basis point rate increase in January was a mistake.
In his note, Colas highlights that since 1990, the Fed has never stutter-stepped at the end of a rate hiking cycle. However, Powell’s recent testimony indicates that the Fed is now contemplating doing so. That introduces the possibility of re-accelerating from 25 to 50 basis point increases.
Despite the optimistic outlook reflected in corporate earnings, Colas remains cautious about U.S. equities. According to him, the value of the S&P 500 index is still too high, given the present uncertainty around interest-rate policy and economic growth.
Colas states that the U.S. equities market is currently in a tug-of-war between corporate earnings and interest rates. Powell’s testimony before the Senate reinforced that the market still doesn’t know where rates will peak. Nor does anyone know how long they will stay there and their impact on the U.S. or global economy.
In a report by FactSet’s senior earnings analyst John Butters, it was noted that the forward 12-month price-to-earnings (P/E) ratio for the S&P 500 has increased to 17.5 from 16.7 since December 31. The index’s price has increased, but the earnings-per-share (EPS) estimates for 2023 have decreased during the same period.
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