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Fed decision: Why investors may be overreacting

Stocks across the board took a hit after the Fed's decision to keep interest rates steady, with the potential for future rate hikes down the line. Data from Bank of America shows investors had their largest exit from equities since last December. Yahoo Finance Senior Reporter Josh Schafer joins the Live show to break down the comments made by Fundstrat's head of research Tom Lee and why the economy may actually flourish.

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.

Video Transcript

- And investors are dumping equities at the fastest pace since December, as the prospect of higher-for-longer interest rates raises the risk of a recession. That's according to Bank of America. Let's bring in Josh Schafer for more details. Josh?

JOSH SCHAFER: Hey, Josh, yeah. So I've got the Chart of the Day here right next to me, courtesy of Bank of America. And it shows those equity asset flows going negative. So what you're looking at here when you look at the purple lines, that would be equity flows going negative, if it becomes below this white flat line we have here.

You can see the spread with our nice little arrow pointing to the largest drop we saw this week-- that's through Wednesday-- that we had seen since 2022. So again, that really comes from that higher-for-longer stance from the Fed when we're talking about interest rates. And so I want to take a look at that as well.

This is the dot plot changes that we saw for economic projections for interest rates earlier this week. In purple, you're looking at June. In blue, you're looking at September. So you can see pretty easily here, purple comes up to where blue is, purple comes up to where blue is. Even going into 2025, guess what? Purple is up higher-- or sorry, blue is up higher than where purple was. So you're seeing that higher-for-longer stance in the dot plot that caused investors to sell off over the last couple of days.

We had the S&P 500 fall by more than 2% from after the Fed meeting Wednesday through the end of yesterday. A little bit of a rally today, but still overall probably going to close this week down.

But there is one investor out there, Tom Lee from Fundstrat, who is still bullish on stocks. And what he points to is why the Fed is coming up with this higher-for-longer stance.

So what I have here is the Fed projections for GDP for economic growth. What you're looking at in blue is what they predicted in June. You can see a lot of those came up, right? We went from 1% to 2.1% for growth this year-- 1.1 next year to 1.5.

So the Fed is thinking the economy is going to grow more. That is what's driving their stance to maybe hike one more time. And what we argue is that's overall good for stocks, because guess what? If GDP is going up, that means the economy is growing. That means price-to-earnings ratios probably go up, and businesses are actually doing well, because again, the economy is growing. We're not in a recessionary environment if the reason the Fed is cutting is because the economy is doing well.

One other positive note to leave you guys with on a Friday. I want to take a look at a little bit of seasonality here. So the S&P likely is going to fall over 1% in September, just as it did in August. The last three times that happened, here are your returns for October. Take a look at that-- up 8%, up 8.3%, up 10%. So we've had bad seasonality through the end of September here, but Lee and some other strategists out there highlighting that might change come October, guys. At least that's what history tells us.

- All right Josh Schafer with some potentially good news heading into the weekend. Josh, thank you.