US Stocks Likely To Open Higher As Fed Says Tariff Induced Inflation Will Be 'Transitory:' Any Pullback In Equities 'Offers An Opportunity,' Says Expert

The Federal Reserve's recent decision to maintain interest rates and acknowledge the transitory nature of tariff-induced inflation has sparked optimism among investors. The central bank's stance, coupled with historical precedents and expert analysis, suggests that any pullback in equities could present a unique buying opportunity. Let's delve into the details and explore the implications for investors.

The Fed's Stance on Tariff-Induced Inflation

The Federal Reserve, under the leadership of Jerome Powell, has acknowledged that President Trump's tariffs are contributing to higher inflation and slower economic growth. However, the Fed believes that this inflation is transitory and will eventually subside. This perspective is reflected in the Fed's decision to maintain the target range for the federal funds rate at 4-1/4 to 4-1/2 percent and its projections for higher inflation and slower growth.



Historical Precedents and Market Behavior

Historical data supports the idea that tariffs can lead to higher inflation and slower growth. For example, the tariffs imposed by the Trump administration in the late 2010s led to significant market volatility and uncertainty. However, there are also instances where periods of rapid economic growth and technological innovation have led to sustained market stability, even in the face of tariffs and other economic challenges.

Key Indicators to Monitor

To assess the transitory nature of tariff-induced inflation, investors should monitor several key indicators:

1. Inflation Rates: The Fed is closely monitoring inflation, which remains somewhat elevated. Recent data shows that core inflation is expected to conclude 2025 at 2.8%, up from the previous 2.5%. This indicates that inflation is a significant concern and could impact long-term investment strategies by influencing interest rates and the cost of borrowing.

2. Economic Growth Projections: The Fed's latest economic projections reveal that real gross domestic product growth is expected to be 1.7% by the end of 2025, down from the December forecast’s 2.1%. This slowing growth, combined with higher inflation, suggests a potential trend toward stagflation, which could affect long-term investment strategies by reducing returns on investments and increasing the risk of economic downturns.

3. Unemployment Rates: The unemployment rate has stabilized at a low level in recent months, and labor market conditions remain solid. In February, unemployment stood at a low 4.1% as employers added a healthy 151,000 jobs. New applications for unemployment benefits remain historically low. This stability in the labor market is a key bright spot in the US economy and could support long-term investment strategies by ensuring a steady supply of labor and consumer spending.

4. Interest Rates: The Federal Reserve has maintained the target range for the federal funds rate at 4-1/4 to 4-1/2 percent. The Committee will carefully assess incoming data, the evolving outlook, and the balance of risks to determine the extent and timing of additional adjustments to the target range for the federal funds rate. Changes in interest rates can significantly impact long-term investment strategies by affecting the cost of borrowing and the returns on fixed-income investments.

5. Tariff Policies: President Trump's tariffs have been a significant factor contributing to higher inflation forecasts for this year. Powell noted that "it’s difficult to gauge how much of the higher inflation expected this year will be due to Trump’s trade war." The uncertainty surrounding tariffs and their potential impact on inflation and economic growth is a critical factor for investors to consider when assessing the transitory nature of tariff-induced inflation and its impact on long-term investment strategies.

6. Market Volatility: The stock market's recent slump, despite the S&P 500 rising 1.1 percent on the day of the Fed's announcement, indicates that investors are concerned about the uncertainty surrounding tariffs. The Cboe Volatility Index (VIX) is another indicator that investors should monitor, as it provides a measure of market volatility and investor sentiment. A high VIX reading suggests that investors are nervous about the future, which could impact long-term investment strategies by increasing the risk of market corrections or bear markets.

7. Yield Curve: The yield differential between 2-year and 10-year Treasury notes is another important indicator to monitor. A flattening or inverting yield curve can signal an impending recession, which could impact long-term investment strategies by reducing returns on investments and increasing the risk of economic downturns. As of Thursday's close, the yield curve was relatively flat, with a differential of +48 basis points.

Opportunities in Market Volatility

The current market volatility, driven by tariff fears and inflation concerns, presents unique opportunities for investors. One key opportunity is the potential for buying during pullbacks or corrections, which are common occurrences in the market. For instance, the S&P 500 has experienced pullbacks of 5% or more from a rolling three-month high 128 times since 1950. Most of the time, investors willing to risk buying these pullbacks were quickly rewarded. However, more than 40% of the time, the dip snowballed into a correction, or something even more serious. Of the 42 corrections identified, nearly 60% went on to become serious corrections, defined as a pullback of between 15% and 20%. This appears to be a major tipping point, because once a selloff entered "serious correction" territory, the probability that a bear market, defined as a drop of 20% or more from the highs, would ultimately follow rose to near 70%.



Strategies to Capitalize on Opportunities

To capitalize on these opportunities, investors can employ several strategies. One strategy is to wait for the market to reach a buyable bottom. For example, Warren Pies of 3Fourteen Research has developed a checklist to help investors decide when conditions are ripe to swoop back in and buy. The checklist includes factors such as the distance away from a recession, where the S&P 500 was trading relative to its 150-day simple moving average, what percentage of the index's constituents were trading above their respective 200-day moving averages, the price-to-earnings ratio of the index, the yield differential between 2-year and 10-year Treasury notes, the level of the Cboe Volatility Index, and what's happening with the 10-year yield.

Another strategy is to take a moment to review your risk profile and prepare for when the next "market correction" arrives. For example, financial markets have historically seen a significant pullback at some point during most years while still delivering positive returns over the full year. In 2018, the S&P 500 saw a market correction of more than 10% in the first quarter of the year and again in the fourth quarter, followed by a rebound of more than 13% in the first quarter of 2019. And the tumble in Q1 2020 was followed by a positive return of 18% for the full year and a gain of more than 100% in less than two years.

Investors can also consider diversifying their portfolios across stocks, bonds, commodities, and cash to help moderate overall portfolio volatility and drawdowns when the equity markets become turbulent. For example, Schwab Intelligent Portfolios is designed to provide broad diversification across up to 20 asset classes in any portfolio, including defensive asset classes such as cash and gold that can help you withstand these inevitable periods of volatility. This broad diversification along with an automated rebalancing process can help provide the discipline to remain calm during periods of short-term volatility while staying focused on longer-term objectives.

Conclusion

In summary, the current market volatility presents unique opportunities for investors to buy during pullbacks or corrections, review their risk profile, and diversify their portfolios. By employing these strategies, investors can capitalize on these opportunities and potentially achieve long-term investment success. The Fed's stance on tariff-induced inflation, coupled with historical precedents and expert analysis, suggests that any pullback in equities could present a unique buying opportunity. Investors should monitor key indicators and employ strategies to capitalize on these opportunities, ensuring that they are well-positioned to navigate the current market environment.