A week ago, conventional market wisdom was still beating the drum of doom. “The Fed is coming,” the bears cried. “Sell while you can.”

But then the Fed actually stepped up with the first post-COVID interest rate hike. Instead of the world ending, a massive relief rally ripped across Wall Street.

The fundamental environment hasn’t changed. The same shadows and threats hang over the horizon.

Now, however, the mood has shifted. And that makes all the difference in the world.

Reason Prevails

The bears had a superficially compelling argument a year ago. Months of free money had left a lot of stocks bloated beyond levels that the market could support under normal conditions.

Take that free money away, the argument ran, and those stocks had no place to go but down. Every time long-term interest rates nudged higher, richly valued stocks looked more and more precarious.

By November, the Fed was signaling an imminent tightening move. Once-beloved names like Block (SQ) and Shopify (SHOP) were in free fall and even giants like Amazon (AMZN) soon lurched into bear market territory.

Between war overseas and persistent inflation at home, it became hard to see how the global economy could hold itself together in any scenario more challenging than a zero-rate environment. Anxiety fed on itself.

Remember that world? That was before the S&P 500 rebounded 6% on news that the Fed was going to get more aggressive cleaning up the free money problem than anyone suspected.

Yes, the rate announcement was hawkish. And yet a weary market found a reason to cheer.

As far as I’m concerned, that’s the fatal flaw in the bear case that dominated Wall Street for the last six months. When you assume that an upcoming event will be terrible, terrible things need to follow in its wake.

When the event takes place and investors cheer, it evidently wasn’t so terrible after all. After months of dread, the end of the free money era was already priced into stocks.

Ever hear the phrase “sell the rumor, buy the fact?” That’s what happened here.

As of last week, the market was no longer extremely overpriced. After all, earnings have held up through waves of inflation and supply chain disruption.

A year ago, we were looking for roughly 15% earnings growth for 2022. That’s roughly in line with what Wall Street as a whole expected to see.

Since then, consensus has come down about 5 percentage points, but there’s still roughly 10% growth ahead . . . despite all the recession fears, higher interest rates, inflation and war.

Under normal conditions, that’s a good growth rate. It’s enough to support a normally bullish year for the market, provided of course that stocks weren’t overpriced to begin with.

And in the past year earnings have actually held up a lot better than we expected, which means stocks that did look overpriced in 2021 have narrowed the valuation gap substantially.

Extremely Sustainable Math

A 22% bear market slide on the NASDAQ went a long way toward closing that gap. Right now, the market isn’t exhibiting any more sign of being in bubble territory than it did in early 2020, before the pandemic hit.

Back then, the S&P 500 supported roughly a 19X earnings multiple on the strength of roughly 10% projected earnings growth. As of today, I wouldn’t be surprised to see 9.3% earnings growth ahead . . . and the S&P 500 is trading at a 19.1X multiple.

If not for the pandemic, would these numbers have crashed the market? It’s a fairly grim thought. I’d like to think Wall Street could have tolerated similar conditions for an extended period of time, but we’ll never know.

And in February 2020, the Fed funds rate was what now seems like an impossibly lofty 1.58%, which is a level the Fed doesn’t expect to hit before November.

November is seven months away. During that time, we’ll bank two quarters of earnings growth, pushing the “E” side of the P/E calculations higher in the process.

Dynamic companies will be that farther along on their trajectories. I hope inflation will recede as the Fed steps up.

I wouldn’t be surprised to see the S&P 500 rally back to record territory in the interim . . . without raising multiples beyond investors’ historical pain points.

We know the market can support these multiples in this kind of interest rate environment. And we know anticipated growth can support at least a little upside.

The Fed seems extremely confident in the economy. If they’re any indicator, recession is unlikely before 2023 at the earliest.

That’s a long time away. Active traders like us will twist with the environment, taking advantage of opportunities and dodging challenges.

Our lives haven’t changed. But maybe it will get easier for awhile now that the rest of Wall Street has recovered its emotional equilibrium.

My rule of thumb is simple. When you think a company can raise the bottom line at a certain rate in the coming year, it’s worth buying up to that earnings multiple.

A stock trading at 18X earnings is a buy when the business is growing at a rate of 18% or more. Everything else is negotiable.

After the last few months, a lot of great growth stocks fit that criterion. Others don’t.

Companies with negative growth rates are still overdone. I wouldn’t buy Amazon (AMZN) right now, for example, unless I was willing to wait around for two years for satisfaction.

That’s a long time for a lot of investors. Who knows how the sentimental pendulum will swing between now and then?