S&P 500 Races Toward 30th All-Time High of 2024

The question now for investors is what will the market do when the Fed eventually does decide to cut? Historically, rate cuts have marked a key inflection point that has ushered in strong equity returns — but only for cycles that aren't triggered by a recession, like this one.

"Improving inflation trends would lead to a more constructive policy outlook, which should be a tailwind for equities and fixed income," said Jason Pride and Michael Reynolds at Glenmede. "Assuming all continues to go well with inflation along a moderating path through the summer, a September rate cut is likely on the table."

Cash in Motion?

Some stock-market optimists have speculated that a swath of the roughly $6 trillion sitting in money-market cash is poised to be reallocated into equities and will give the rally another boost.

But a growing number of soothsayers at firms ranging from Morgan Stanley to Deutsche Bank AG are poking holes in that theory. With generous yields on cash amid elevated interest rates, it's no surprise that inflows to money market funds just hit another all-time high. Yet, there's little evidence to suggest that cash is going to move into riskier assets anytime soon.

"Choppiness and a flight to quality are likely to dominate the markets until the Fed clarifies the scope and timing of rate cuts," said Robert Teeter at Silvercrest Asset Management. "This guidance may come as early as the Jackson Hole event in August."

Many stocks are now becoming more sensitive to softer growth conditions, according to Morgan Stanley strategists led by Michael Wilson. They say some value/cyclical stocks have started to focus more on earnings expectations and less on the impact of interest rates

"This development is in line with our consistent view that higher rates are a clear headwind to small caps, but lower rates don't offer a comparable benefit," they wrote.

Stock, Bond Correlation

The correlation between stock prices and bond yields continues to invert and is the most negative since 1997, suggesting a major shift in the inflation regime is likely underway and that stock prices and bond yields may together remain subject to extreme sensitivity to inflation trends, according to according to Bloomberg Intelligence strategists led by Gina Martin Adams.

"The correlation between the two asset classes was positive for the better part of 20 years, suggesting disinflation was the dominant regime," they said. "The positive correlation historically implied that equities trended in the direction of yields as inflation mostly coincided with growth."

The shift in the correlation to negative might be signaling a significant longer-term change in inflation conditions has begun, the BI strategists noted. Stocks held a negative correlation to yields throughout most of the 1980s and 1990s, when inflation hurt equities.

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