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After weeks of declines in the stock market, especially the once-hot tech sector, stocks have bounced. Commentators say investors are finding reasons to be optimistic.
This positive spin was applied to the Federal Reserve’s most recent policy meeting, where officials said they still expect two interest rate cuts this year. At the same time, Fed Chair Jerome Powell repeatedly emphasized the high uncertainty in the outlook, thanks to President Donald Trump’s trade wars. Relatedly, stocks rallied as the latest back and forth on tariffs suggested that for now, the worst-case levies would not be imposed (even as many economists didn’t have those scenarios in their base cases).
Against this backdrop, is the market out over its skis? Strategists say that while uncertainty and volatility may persist in the short term, the market is pricing in solid fundamentals in the longer term.
Why Have Stocks Bounced?
Investors breathed a sigh of relief on Friday, as stocks notched their first weekly gain since mid-February, buoyed by an unexpected rally in the wake of the Fed’s March meeting. The Morningstar US Market Index climbed another 1.9% on Monday, amid news that the next round of Trump administration tariffs slated to go into effect April 2 may be smaller than previously thought.
In their forecasts last week, Fed officials made it clear that they expect slightly higher inflation and lower growth over the near and medium terms. The Fed now sees GDP growth of 1.7% this year, down from 2.1%. Meanwhile, across Wall Street, economists are revising down their forecasts for growth, even absent a worst-case tariff scenario. At JPMorgan, forecasters peg the chance of a recession this year at 40%.
Meanwhile, consumer sentiment has plummeted amid headlines about trade wars, government layoffs, and stubborn inflation. On Tuesday, the widely watched Conference Board consumer confidence monthly survey found that expectations fell to their worst levels in a dozen years—a reading that often signals a recession. That’s an economic scenario that doesn’t seem like it should bode well for stocks.
Is the Stock Market Outlook Still Constructive?
However, strategists say this is where it makes sense to zoom out. Stocks dipped into correction territory (meaning a 10% drop from the most recent peak) earlier this month. Yet over a six-month period, the market is essentially flat, and for the past 12 months, stocks are up more than 11%. And while strategists say investors shouldn’t expect the same 20%-plus returns seen in 2023 and 2024, the fundamentals for the year ahead are deemed solid.
“A lot of the setup that was constructive as we started the year is still in place,” explains Denise Chisholm, director of quantitative market strategy at Fidelity Investments. She says earnings are in good shape and tax cuts could be on the horizon. The Fed is also winding down quantitative tightening—the process by which it trims its holdings of bonds to help slow the economy and fight inflation.
Chisholm says that historically, the less stocks fall over a six-month period, the more likely it is that they will rise over the next six and 12 months. “It’s almost like the fact that stocks aren’t down a lot predicts that the crisis isn’t as bad as you might think,” she says.
A Bullish Take on the Fed Meeting
Strategists say this helps explain why stocks rose after last week’s Fed meeting, even though officials indicated that inflation is still above their target and growth is poised to slow. Taken to their extreme, lower growth and higher inflation could create a stagflationary scenario—a potentially dire circumstance, but not one that is an immediate risk for the economy, according to many analysts.
Fed officials and market watchers anticipate a much milder change in the outlook. John Hancock Investment Management co-chief investment strategist Matt Miskin says, “What you’re seeing is sturdy but weak, slower growth” of 1% or 2%, along with inflation higher than the Fed’s target but nowhere near the multi-decade highs of 2022. “I think market is looking through that.”
On top of this, Fed officials signaled that they are ready to step in should the economy slow, even if that means letting inflation run slightly above target. “That’s really what caused the market to respond more favorably, the thought that the Fed would look through the inflation issues and help the economy if it became weaker over the year,” Miskin says.
Adds Chisholm: “The fear was that the Fed thought inflation was rising enough that they were not going to cut rates and maybe would have to hike rates this year.” Central bankers sent a much more dovish message.
“Looking Through” the Current Worries
One idea popping up on Wall Street in recent days holds that investors are “looking through” short-term pain toward a more constructive medium- and longer-term outlook once the tariff uncertainty and monetary policy questions are in the rearview. They say the stock market is a forward-looking machine.
“We are living day to day on what’s happening, what could potentially happen on April 2 [with tariffs],” says Joe Quinlan, head of CIO market strategy at Bank of America Private Bank and Merrill. He adds that it wouldn’t be surprising to see the market bounce around as investors and analysts digest new developments. “But the bigger picture is … an economy that’s still expanding. We’ve got inflation a little stickier than the Fed wants, but that’s a pretty good backdrop for earnings overall.”
And then there are the Trump administration’s priorities beyond tariffs, which could boost stocks rather than weigh on growth. “The equity market is still holding on to the idea of a lower-regulatory, lower-tax environment,” says Drew Matus, chief market strategist at MetLife Investment Management. “It’s probably a reasonable, forward-looking bet to make that in time, this administration will focus on lowering the number of regulations [and] extending tax policy, and that it will be good for economic activity going forward.” While the market has spent the better part of the last few months shuddering on the back of new tariff news, Matus says, “longer term, there is this undercurrent of a positive dynamic that people are having to price in.”
Quinlan says, “I think the markets, if they had more clarity around trade, would fall back on the assumption that we have a good economy, a little higher-than-expected inflation, a good earnings outlook. That’s being built into prices right now.” If the tariff outlook changes, he says, “the market’s going to have some digestion problems.”
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.
