by David Randall

NEW YORK (Reuters) – The rally in U.S. stocks faces a potential turning point next week as the Federal Reserve is expected to deliver the final rate hike of its most aggressive monetary policy tightening cycle in decades.

As the year began, many investors expected higher interest rates to lead to a recession that would further hurt stocks after a sharp 2022 decline. Instead, the US economy is proving resilient, even as the Fed makes progress in fighting inflation — an ideal “Goldilocks scenario” that many believe will support equities. It is up nearly 19% year-to-date and closed at 4,534.87 on Thursday, only 6% below its all-time high in January 2022.

While investors broadly expect the central bank to raise rates by 25 basis points at its July 26 meeting, many are also hoping for signs that policymakers have more confidence that inflation will continue to soften, eliminating the need for the Fed to raise borrowing costs further and supporting a thesis that has helped stocks rally in recent weeks.

“A large portion of the market is still macro-driven and inflation is still in the driver’s seat. What the Fed does and says next week will be critical,” said Cliff Corso, chief investment officer at Advisers Asset Management.

Expectations of a benign macroeconomic backdrop and an end to Fed tightening have some analysts wondering how high stocks will go this year.

Credit Suisse’s Jonathan Golub raised his year-end target on the S&P 500 to 4,700 from 4,050 on Tuesday, citing a strong economic outlook and strong technology and communications services earnings expectations.

Tom Lee of Fundstrat Global Advisors raised his year-end target earlier this month to 4,825, while Ed Yardeni of Yardeni Research sees the S&P 500 at 5,400 over the next 18 months.

Meanwhile, a gauge tracked by the National Association of Active Investment Managers showed stock pickers’ exposure to equities is at its highest level since November 2021, months before the Fed begins its rate hike cycle.

“The bearish investors have had to capitulate,” said Liz Ann Saunders, chief investment strategist. charles schwab (NYSE:). “We are seeing a fundamental backdrop of low inflation, resilient economic data, improved consumer confidence and a falling dollar which is a very good recipe for gains.”

Eric Friedman, chief investment officer at US Bank Wealth Management, has increased his stock holdings in recent months and is more bullish on the tech sector on hopes that companies’ earnings will improve as the economy remains resilient.

“Consumers have been supported by a tight jobs market and some solid real wage growth, and we are also seeing some real progress on the inflation front,” he said.

At the same time, forecasts of a recession – as seen as already predicted at the beginning of the year – are becoming less dire.

Goldman Sachs (NYSE: ) on Monday cut the chance of a US recession starting in the next 12 months to 20% from an earlier forecast of 25%, believing that easing inflation could open the way for the Fed to lower rates without recession. The bank last month raised its year-end S&P 500 target to 4,500 from 4,000.

Yet many strategists are bearish, worried about surprises ranging from the shortfall in the current earnings season to the sustainability of inflation.

Sunita Thomas, Senior Portfolio Manager Northern Trust (NASDAQ: ), believes inflation will prove more stubborn than expected and has cut investments in equities in recent months.

“We’re telling clients that the market is doing great for some very good reasons, but now is a good time to rebalance,” he said.

Rising valuations have been another concern, with the S&P 500 now trading at 20.8 times forward earnings, up from about 16 times at the start of the year.

However, Christopher Tsai, chief investment officer at Tsai Capital, isn’t worried about buying into an overvalued market. He has added eight companies to his portfolio this year, including index provider MSCI Inc. and Animal Health Co. Zoetis Inc (NYSE: ), he believes has been overlooked in the market’s progress.

He said, “It’s hard to find names that have been given a lot of importance.”