Momentum and FOMO can drive stocks even higher - but the buying frenzy might end abruptly, Wharton's Jeremy Siegel says

• Investors are putting more weight on economic data than looming rate hikes, Jeremy Siegel says.
• Momentum and FOMO could drive stocks higher in the short term, the professor says.

Investors are brushing off the prospect of higher interest rates and piling into stocks, but the buying frenzy might end abruptly, Jeremy Siegel has warned.

"The market is currently prioritizing the strong economy over fear of the Fed," the retired Wharton finance professor said in his weekly WisdomTree commentary, published on Wednesday. "We will see how long that can last."

The Federal Reserve's battle against historic inflation has centered on raising interest rates from nearly zero last spring to north of 5% today, and the US central bank has penciled in a couple more hikes this year. Higher rates boost the appeal of bonds and savings accounts relative to stocks, and typically erode corporate profits by increasing companies' interest costs and curbing demand from consumers and businesses. As a result, they tend to pull down the prices of stocks and other risky assets.

However, the US economy has proven resilient to the Fed's hikes, with growth and employment both holding up in recent months. Investors are betting on stocks because they believe the US can escape a recession, and companies can withstand the pressure of higher rates.

Siegel questioned why the Fed is still pressing forward with rate hikes even though inflation has dropped from a high of 9.1% last summer to 4% in May. He suggested that Fed officials may believe a buoyant economy will fuel inflation, even though current prices of oil and other commodities don't support that view.

"What surprises and disappoints me … is that the Fed continues to escalate its tightening and hawkish stance," he said.

Siegel also touched on the housing market. Home prices have climbed for three straight months, and are now up 40% in a relatively short period. Combined with a 65% rise in average mortgage costs, affordability has dropped sharply, meaning it's likely that cash buyers are the ones pushing up prices, he said.

The veteran commentator weighed in on the chances of an economic slump too. "I believe we still have elevated risks of a downturn in the second half of the year due to potential negative shocks," he said, suggesting the Supreme Court's decision to block forgiveness of student loans could hurt consumer spending, and a looming UPS strike may disrupt national supply chains.

Given the mixed backdrop, Siegel issued a cautious market outlook. "I think momentum and fear of missing out on gains can take the market higher over the short run," he said, before warning the rally could lead to stocks becoming overvalued.

The author of "Stocks for the Long Run" also warned that bad news such as weaker jobs data could dampen the positive sentiment in markets. But he emphasized that some value stocks are already priced for a mild recession, meaning they could pay off even if conditions worsen.