2024-01-21 19:27:00
The stock market may not have gotten what it expected from the Federal Reserve yet, but it may get what it needs from a US economy that simply refuses to give up.
The rally that ended in 2023 was based on the assumption that whether the Fed is ready for it or not, it will start lowering interest rates in 2024. This assumption became even more plausible after the Fed’s meeting on December 13, when Powell hinted that the rate hike cycle had come to an end. In the last months of last year, the S&P 500 rose by 14%, while the yield on the 10-year US Treasury bond fell to 3.86%. Since then, the representatives of the Fed, Christopher Waller and Rafael Bostic, have undermined the confidence of investors regarding the timing of the interest rate cut and the assumption that the move will actually happen.
In addition, the economic data released in the past week further supported the recent statements of the Fed officials. Retail sales rose 0.6% from November to December, the biggest increase since September 2023 and the first time that jobless claims fell by 18,000 to 187,000, a 16-month low. Moreover, the University of Michigan’s Consumer Sentiment Survey, which surveys how confident and optimistic consumers are about the economy, jumped 9.1 points to 78.8 in January, the largest increase since 2005, as inflation expectations fell to their lowest level in three years while expectations for good economic conditions more overcome.
The probability of an interest rate cut in March, which investors were excited about at the beginning, dropped to 46.2% from 79% before.
The beginning was not good
It initially looked bad for the stock market, as economic data showed the economy was still strong, reducing the likelihood of an imminent rate cut. In response the S&P 500 fell 1.1% during the first two days of last week. However, by Friday, the index had already risen 1.2% and closed at an all-time high. Even the spike in the 10-year bond yield to 4.145%, the highest level in more than a month, failed to get investors to pull the money out of the stock market.
All this makes no sense if the factors driving the market today are the same as those that drove it at the end of last year. The fact that the market is holding up as well shows that something is starting to change, at least below the surface: the market is starting to price in more economic growth and fewer interest rate cuts. While this hurt some of the more defensive sectors of the market: the services sector UTILITIES SELECT SECTOR SPDR FUND -0.13% Close: 0 Open: 61.12 High: 61.22 Low: 60.59 Turnover:– Page Quote News Graphs Company Profile Recommendations More articles on the subject: – Shird in -3.7% in the last week and the real estate sector. %, it wasn’t terrible for the overall market.
Fewer interest rate cuts
Wells Fargo noted that the difference between investment-grade bonds and the government bond yield was only 0.99 percentage points at the end of 2023. This is the seventh time since 1998 that the spread was less than a percentage point at the beginning of a year. In those years, the gross domestic product increased by an average of 2.2%, with the only year in which it decreased was 2020 when the corona epidemic forced a halt on the economy. Recession years started with a margin of 1.98 percentage points or higher. According to analysts at Wells Fargo, that figure suggests growth of 2% or more this year and far fewer rate cuts than the stock market expects.
Such a change could be difficult for the stock market. Even the expectation of lower interest rates can often support higher valuations, as occurred in 2023, when the S&P 500’s 12-month forward earnings multiple rose from 17.48 to 19.62 at the end of the year. Higher interest rates, on the other hand, or even the expectation that interest rates will not go down as much as first thought, could bring valuations down.
Worse, the optimism about the economy may prove to be unfounded if the Fed delays interest rate cuts and plunges the economy into recession.
However, if we take the optimistic side, if the economy remains as strong as it appears, it could provide a boost to the stock market to continue trading higher. If stronger growth translates into stronger profits, it will also benefit small stocks and could result in a situation investors haven’t seen in a long time: the market will react as it should to good news.
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