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Chart of the Day - multiple expansion
I have seen a posts on social media talking about the impending multiple expansion in stocks once the Fed stops hiking rates. In fact it is not that simple. But again, I am biased, so I though I would ask an unbiased friend

So I asked Bing (for the record I use Google Chrome but have only started occasionally using Bing for the AI, not entirely sure why I felt I need to say that but I did), "Does the S&P 500 Price to Earnings ratio rise when the Federal Reserve stops hiking the Fed Funds Rate?"

Bing said: "There is no definitive answer to how the S&P 500 P/E ratio changes when the Fed stops hiking the Fed funds rate, as it depends on many other factors such as earnings growth, market expectations, inflation, & risk appetite. However, some possible scenarios are:

If the Fed stops hiking rates because it sees signs of economic slowdown or financial stress, then the S&P 500 P/E ratio may decline as investors become more cautious & demand higher returns for holding stocks. This could happen if the recent banking failures or trade tensions escalate into a broader crisis.

If the Fed stops hiking rates because it believes inflation is under control & the economy is growing at a sustainable pace, then the S&P 500 P/E ratio may increase as investors become more optimistic & willing to pay higher prices for future earnings. This could happen if consumer spending, manufacturing activity, & job growth rebound after a temporary soft patch.

If the Fed stops hiking rates because it is uncertain about the outlook & wants to wait for more data, then the S&P 500 P/E ratio may remain stable or fluctuate within a range as investors balance the risks & opportunities in the market. This could happen if inflation & economic growth moderate but remain close to the Fed’s targets."

I did not watch the presser or the reaction but John Authers at Bloomberg did. This is from his note on the reaction to the news yesterday, so we can gather which of those AI scenarios the market may be focused on:

"It’s worth taking a look at the full press conference... Powell got into trouble when answering questions about exactly what would prompt cuts. Having watched it a couple of times, I think he was trying to hold the line that the market shouldn’t price them in, saying that in the world the Fed envisaged there wouldn’t be a case for easing this year. Unfortunately, he introduced the idea that, of course, others might have different opinions about the economy, and if they were right then the Fed would need to loosen rates."

The chart today shows you one of each of those scenarios. #2 of sustainable growth & inflation under control is the mid to late 90s. #1 is the great financial crisis of the mid 00's. I think we may be in #3 myself where the outlook is uncertain. John seems to think maybe we are #1. The market until now seems to think #2. Let me know your thoughts

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Nathan Worden's avatar
Nathan Worden
@nathanwordenMay 4
If the Fed stops hiking rates, my take is that multiples would stay where they are. It would take rates lowering for multiples to expand. From a very simple-minded perspective at least.
Rich Excell's avatar
Rich Excell
@stayvigilantMay 5Author
@nathanworden I am sympathetic to those who see this as the late 90s. I do not feel we are anywhere near the Great Fincl Crisis myself. However, there is a lot of uncertainty on whether the FOMC has gone too far or if stopping now risks a re-acceleration as we saw in the early 80s because the fiscal expansion is not slowing. at the very least, my instinct is that multiples should not expand with uncertainty but stocks with positive earnings can still go higher. I think we need to be reality led and not expectation led
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