Both the Fed minutes and Powell's Jackson Hole speech indicated the rate cut cycle will start in September and validate our view that the Fed will cut three times this year. We do not expect any 50bp cuts from this Fed as it has acknowledged that it has no ability to accurately forecast inflation or the economy so it will move cautiously.
To cut rates the Fed must expand the money supply by injecting reserves into the banking system. This liquidity injection is extremely likely to cause both stock and bond markets to rise. We are even more confident about our 6,000 target on the S&P 500 index after the recent 10-year rally to the 3.80% area. The most controversial element of our bullish call was our forecast that the 10-year would drop to the 3.25-3.5% range, which is required to justify the 21x earnings estimate on the S&P implicit in our 6,000 target. The recent rally in treasuries demonstrates that monetary policy is a far more important driver of long-term rates than ongoing fiscal irresponsibility.
The market is always subject to pull-back during the weak August/September time frame, but we see a strong report for the S&P in the 5,000 area, which is the 200-day moving average. In addition, the Fed has indicated it will cut rates in September, which will very likely support the market as hedge funds and other short-term investors are unlikely to want to be too short heading into that meeting.
Our bullish target assumes a divided government and no significant corporate tax increase. Corporate tax rates are 60% correlated with economic growth and have very direct impacts on the level and growth rate of corporate earnings. We estimate that a 28% corporate tax rate would lower our theoretical S&P 500 index price target 20%, which will be reflected over time and is likely to cap price appreciation in stocks over the next year despite the power of Fed rate cuts.
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