Despite a Friday stumble, stocks ended a turbulent week with another round of solid gains, keeping 2023’s young but robust stock-market rally very much alive.
But a cloud of confusion hangs over the market, and it will eventually need to be resolved, strategists said.
Stocks rose early in the week as traders continued to bet that the Federal Reserve won’t follow through on its forecast to push the federal funds rate to a peak above 5% and hold it there, instead looking for cuts by year-end. Fed chief Jerome Powell pushed back against that expectation again on Wednesday, but a nuanced answer to a question about loosening financial conditions and an acknowledgment that the “disinflationary process” had begun convinced traders they remained right about the rate path.
On Friday, however, a blowout January jobs report, with the U.S. economy adding 517,000 jobs and the unemployment rate dropping to 3.4%, its lowest level since 1969, appeared to affirm Powell’s position.
Stocks took a hit, but still saw the Nasdaq Composite
book a fifth straight weekly gain and the S&P 500
achieve back-to-back weekly wins. The Dow Jones Industrial Average
suffered a 0.2% weekly fall. Stock-index futures pointed to a lower start for Wall Street on Monday.
“It kind of leaves you shaking your head right now, doesn’t it?” asked Jim Baird, chief investment officer at Plante Moran Financial Advisors, in a phone interview.
At some point in the coming months there will need to be “a reconciliation between what the markets think the Fed will do and what Powell says the Fed will do,” Baird said.
The rally could continue for now, Baird said, but he argued it would be wise in the long run to take the Fed at face value. “I think the overall tone of risk taking in the market right now is a little bit too optimistic.”
Money-market traders did react to Friday’s data. Fed funds futures on Friday afternoon reflected a 99.6% probability that the Fed would raise the target rate by 25 basis points to a range of 4.75% to 5% at the conclusion of its next policy meeting, on March 22, up from an 82.7% probability on Thursday, according to the CME FedWatch tool.
For the Fed’s May meeting, the market reflected a 61.3% chance of another quarter-point rise to 5% to 5.25%, the level the Fed has signaled is its expected high-water-mark rate. On Thursday, it saw just a 30% chance of a quarter-point rise in May. But markets still look for a cut by year-end.
Of course, one month’s data do not represent the end of the argument. But unless January’s labor-market strength turns out to be a blip, the hawks on the Fed are likely to dig in and keep rates higher for longer, said Yung-Yu Ma, chief investment strategist at BMO Wealth Management, in a phone interview.
For markets, the lack of a resolution to the long-simmering disconnect with the Fed could lead to a period of consolidation after an admittedly impressive start to 2023, he said.
Indeed, the momentum behind the market’s rally could be set to continue. It’s been led by tech and other growth stocks that were hammered in last year’s market rout. Market watchers detect a sense of “FOMO,” or fear of missing out, is driving what some have termed a tech-stock “meltup.”
“The impressive equity rally to start the year has caught cautious institutional investors, hedge funds, and strategists off guard. While overbought conditions are obvious, the near-universal level of skepticism among institutions provides a contrarian degree of support for continued strength,” said Mark Hackett, chief of investment research at Nationwide, in a Friday note.
‘Mood of forgiveness’
And then there’s earnings season, which has so far seen results from around half of the S&P 500.
Companies through Friday had reported lower earnings for the fourth quarter relative to the end of the previous week and relative to the end of the quarter.
The blended earnings decline (a combination of actual results for companies that have reported and estimated results for companies that have yet to report) for the fourth quarter was 5.3% through Friday, compared with an earnings decline of 5.1% last week and an earnings decline of 3.3% at the end of the fourth quarter, according to FactSet. If earnings come out negative for the quarter, it would be the first year-over-year decline since the third quarter of 2020.
When it comes to earnings, “there’s definitely been a mood of forgiveness in the market,” said BMO’s Ma.
“I think the market just didn’t want to see a disastrous earnings season,” he said, noting expectations remain for weak earnings in the current quarter and next, with bulls looking into the second half of this year and even into 2024 to get on a better footing.
For the market, the main driver will remain data on inflation and wage growth, Ma said.
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