Wells Fargo (NYSE:WFC) equity strategists believe that the U.S. economy will likely avoid a recession and steadily strengthen through next year. This, combined with easier financial conditions, should support continued growth in corporate earnings and maintain strength in equity markets, the investment bank said Monday.
It's been over a year since the Federal Reserve last raised the federal funds rate. During this period of policy pause, equities have surged, reaching record highs. However, recent market volatility and weakening economic data have raised concerns that the Fed might need to cut rates aggressively to prevent a U.S. recession.
"Our view is that the Fed will reduce rates in September as it shifts from fighting inflation to stimulating the economy and hiring,” Wells Fargo strategists noted.
“While a recession is possible, our work suggests a greater likelihood of a near-term economic slowdown, followed by a recovery in 2025."
Historically, the reason behind the Fed's decision to ease policy has played a crucial role in equity market performance.
Since 1974, the average market drawdown has been about 20% over the 250 days following the Fed's first rate cut. However, this average includes several bear markets linked to economic and earnings recessions—a scenario that Wells Fargo views as unlikely in 2025.
A closer examination of the data reveals a different outcome in non-recessionary periods. When the Fed cuts real rates in response to falling inflation, rather than a rapidly weakening economy, "equities have performed quite well,” strategists emphasize.
In the past, the S&P 500 has typically continued its upward trend for 18 months following the initial rate cut during periods when the Fed's easing cycle did not coincide with a recession. In contrast, when the rate cut cycle aligned with a recession, market performance tended to be choppy, ultimately ending flat over the 18-month period.
The strategists also draw comparisons between the current environment and the mid to late 1990s, particularly 1995, when the Fed began a rate-cutting cycle amid disinflation and an economic soft landing.
Although the two periods are not identical, the strategists believe that the 1995 scenario could serve as a potential guide for corporate earnings and equity prices in the coming quarters. In that scenario, the S&P 500 Index saw a 12% increase in earnings in the year following the initial rate cut, which is close to Wells Fargo's forecast.
While acknowledging the parallels with 1995, the strategists also note that each cycle has unique characteristics. For instance, inflation peaked at a much higher rate during the current cycle, and the Fed has maintained peak rates for a longer duration.
"Even so, we think the U.S. economy will avoid a recession and gradually strengthen through 2025,” they wrote.
“This, along with easier financial conditions, should support continued corporate earnings growth, equity-market strength, and our favorability toward high-quality companies within U.S. Large Cap Equities."
The S&P 500 ended last week nearly flat, clawing back the bulk of its losses it experienced on Aug. 5.