Fed's real interest rate cycles in last 50 years 'typically ended at over 2%': Strategist

Stifel Chief Equity Strategist Barry Bannister joins Yahoo Finance Live to discuss inflation, the Fed rate hikes, the economic outlook, and what to expect in the next Fed meeting.

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- If this week's inflation data is any indication, the end of rate hikes might be within sight. The Consumer Price Index, a key inflation gauge, up 4.9% from a year ago. That's just a touch lower than March's 5% figure. And the Producer Price Index, that PPI, as you note in your hood, which the Fed prefers, rose 2.3% on an annual basis, below estimates and the slowest annual increase since January of 2021.

Now, markets, they are pricing an 84.7% chance of a pause in June as of this morning. That's down slightly from the day prior. With one month to go until the Fed's next meeting, our next guest is keeping the bullish sentiment in the near term, raising its target on the S&P 500.

Barry Bannister is chief equity strategist at Stifel. He joins us now. Barry, walk us into your target here and, ultimately, what you're anticipating the tenor or the tone in the conversation, at least, at the next Fed meeting to be.

BARRY BANNISTER: Well, back in October 24 of 2022, we came out with a bullish view that the S&P 500 would rise as much as 600 points from-- at the time it was around 3,575, 3,580. we thought it would do it in six months by the end of April. Of course, there's been a good direction up. The first 500 points of that move, which would be led more by cyclical than defensive-- and cyclical includes big tech as well as industrials, and we talked about that-- that that first 500 points was the easy money. All that required was things not to go wrong, in other words, no near-term recession and lower inflation, which were our call.

But the next few hundred points, 250 points or so, to 4,400 by the summer, that's the hard money. The easy money is behind us. The hard money is here. And that requires things not to go-- before it was not to go wrong. Now things have to go right.

We are seeing encouraging signs, though, of economic resilience. Consumers are still sitting, households on $1.2 trillion of cash, far and away above the normal trend line. Businesses are fairly flush with cash. EBITDA to interest coverage ratio and so forth looks very good.

I don't see the makings of a near-term recession. What we are looking at, though, is some problems probably by the fourth quarter of the year. So it is a short-term call.

- Well, and Barry-- hi. It's Julie here. It's good to see you. I noted that mention of economic resilience in your note. At the same time, we're hearing from the likes of Federal Reserve Governor Michelle Bowman, who's speaking in Europe this morning, and saying there is the potential for another interest rate increase. That's something that other strategists have floated as well.

If that economic resilience comes with another rate increase, is that going to be damaging to Markets In other words, if everything has to go right, does that include a pause from the Fed? Does that fall into the category of going right?

BARRY BANNISTER: Well, keep in market-- keep in mind that two things have happened. One, earnings have actually come out a little better than expected. If you take the percent of companies the S&P 500 index that beat the estimate and subtract that missed the estimate, so the beat-miss difference, it actually turned up nicely in the first quarter. And when that has happened in the last 20 years, the S&P 500 on a year-over-year basis starts to go up. And it's doing it again.

The second thing is if I look at the interest rate, it is about 5%, 5.25%. And that's from the Fed. Keep in mind that inflation is closer to mid-4s. So the real interest rate, the interest rate after inflation is a little less than 1%.

Fed cycles in the last 50 years, since 1971, typically ended at over 2% real rates. And so we're not really that tight. We just came from sub-basement level 5. In other words, we were at minus 5%, 5 and 1/2% interest rates after inflation when the Fed cycle began. And we've only caught up to barely above zero.

The other rate that matters is what's called the 10-year Real Yield, or 10-year Treasury Inflation-Protected Securities, or TIPS yield. Very important for valuation. That is around 1.2. If you look at the preglobal financial crisis era, it was always around 2 to 2.5. So we're at half the real yield of the past. So it does preserve valuation and enables stocks to have a higher valuation when interest rates after inflation are actually quite low versus history.

- Where is the largest valuation upside from an equity perspective?

BARRY BANNISTER: Well, we've seen strength in technology, which is software, semiconductors, computer hardware, which includes Apple. And we've seen some strength in selected communication stocks, such as the internet. Typically they can go higher on the valuation than where they are now. And the most beaten-down, downtrodden names, like banks and some of the industrials, some of the basic materials, represent good value if we can avoid a recession certainly into late in the year.

So what we've done is barbell. We think that there's still some upside on the tech, consumer media, communications-related names. And also there are some downtrodden value in the names I just mentioned, such as banks and industrials and materials. So we would barbell the two into the summer and have a weighting in both.

What I would avoid is making a defensive bet, everything from pharmaceuticals to utilities to household products. They just don't look interesting to us right now.

- Hmm. Interesting. Interesting that you find them interesting. Barry, thanks so much Barry Bannister, chief equity strategist at Stifel, good to catch up with you this morning.