US Economy's Resilience and the Stock Market
Wells Fargo equity strategists suggest that the U.S. economy is on track to avoid a recession and strengthen steadily through next year. This prospect, combined with easier financial conditions, is expected to bolster corporate earnings and support the strength of the equity markets.
Federal Reserve's Rate Strategy
It's been over a year since the Federal Reserve last raised the federal funds rate. During this time, equities have surged to record highs. However, recent market volatility and weakening economic data have raised concerns about the potential need for the Fed to cut rates aggressively to stave off a U.S. recession.
Wells Fargo strategists anticipate that the Fed will likely reduce rates in September, shifting focus from combating inflation to stimulating economic growth and employment. While a recession remains a possibility, they suggest a more likely scenario of an economic slowdown followed by recovery in 2025.
Historical Context and Market Performance
Historically, the rationale behind the Fed's decision to ease policy significantly impacts equity market performance. Since 1974, the average market decline has been about 20% over the 250 days following the Fed's first rate cut. This average includes several bear markets associated with economic downturns—a scenario Wells Fargo views as unlikely in 2025.
In non-recessionary periods, when the Fed cuts rates in response to declining inflation rather than a weakening economy, equities have generally performed well. For instance, the S&P 500 typically maintained an upward trend for 18 months after the initial rate cut in such conditions.
Comparisons to the Mid-1990s
The current environment bears similarities to the mid to late 1990s, particularly 1995, when the Fed began a rate-cutting cycle amid disinflation and an economic soft landing. Although there are differences, such as higher peak inflation in the current cycle, the 1995 scenario could serve as a guide for future corporate earnings and equity prices.
In 1995, corporate earnings saw a 12% increase in the year following the initial rate cut, aligning closely with Wells Fargo's forecast. Despite unique characteristics of each cycle, the strategists believe that the U.S. economy will avoid a recession and gradually strengthen through 2025.
Conclusion
This economic resilience, along with easier financial conditions, is expected to support continued growth in corporate earnings and maintain the strength of equity markets. Wells Fargo expresses a favorable outlook on high-quality companies within U.S. Large Cap Equities. The S&P 500 ended last week nearly flat, recovering most of its losses from earlier in August.
