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Stock Market Shrugs Off Recession Signals as Rally Builds
S&P 500 is trading at its highest level since April 2022 as hopes grow for a soft landing
WSJThey point to worrying economic signals, lofty equity valuations and the possibility that the Federal Reserve continues raising interest rates or keeps them elevated longer than the market anticipates. The S&P 500, meanwhile, has advanced 19% this year even as analysts expect 2023 corporate earnings to come in flat.
“There’s not a lot of leeway for bad news right now in equities,” said Mike Mullaney, director of global markets research at
Investors are all but certain that the central bank will raise interest rates by a quarter percentage point Wednesday. Their focus is on the future: any sign of whether Fed officials expect to lift rates higher from there.
Not long ago, brutally hot inflation and the Fed’s plans to fight it made the prognosis for markets and the economy appear bleak.
Since the early 1950s, every episode of significant U.S. disinflation, each of which was driven at least partly by Fed tightening, has been accompanied by recession, according to Deutsche Bank research. That has been bad news for stocks: In recessions since the late 1940s, the S&P 500 has fallen a median of 24%, according to the bank’s research.
Last year the stock market seemed to be signaling such a contraction, with the S&P 500 sliding 25% from its high in January 2022 to its low in October.
Many investors expected more of the same at the start of 2023. Instead, stocks roared higher out of the gate. The S&P 500 emerged last month from its longest bear market since the 1940s and has now climbed 28% from its bottom. It ended Tuesday at its highest close since April 2022.
Inflation has cooled and the economy keeps motoring along. The jobs market remains robust, with the unemployment rate hitting a 53-year low earlier this year before ticking up just slightly. Americans have been spending more at retail businesses. Economists are raising estimates for gross domestic product in the second and third quarters.
“There’s an actual chance here the Fed could stick the landing,” said Dryden Pence, chief investment officer at Pence Capital Management.
Still, there are reasons for concern. The Conference Board said last week that its leading economic index fell for a 15th consecutive month, signaling slowing economic activity ahead. That is the index’s longest streak of declines since a span from the spring of 2007 through early 2009. The U.S. economy fell into a recession in December 2007 and didn’t exit until June 2009.
The bond market is flashing another warning sign. Normally, longer-term U.S. Treasurys carry higher yields than shorter-term ones, paying investors for the risk that interest rates rise or inflation accelerates. When the longer-term yields are lower, it often suggests that investors think the Fed will need to cut rates to resuscitate the economy.
The yield on the benchmark 10-year U.S. Treasury note has been lower than that of the 2-year Treasury for more than a year, the longest streak since a span ending in 1980, according to Dow Jones Market Data.
There have also been glimpses of weakening in the market for bank loans. Loan officers at U.S. banks told the Federal Reserve earlier this year that they had tightened lending standards for households and businesses and seen lower demand from borrowers. Tighter lending conditions can weigh on economic growth as firms pull back on investment and hiring and consumers have less money at their disposal.
Hans Olsen, chief investment officer at Fiduciary Trust, said he finds the stock market’s rally perplexing given the warning signs from various economic indicators. His firm sold U.S. stocks in April and is holding more cash than usual to protect against a market downturn, he said.
“When you looked at that data set, you went, hold on here, this kind of looks like a classic slowdown in an economy that eventually slides into some form of contraction,” Olsen said.
Such concerns come as the stock market is boasting rich valuations relative to history. The S&P 500 traded early this week at 19.7 times its projected earnings over the next 12 months, up from 16.8 at the end of last year and above a 10-year average of 17.7, according to FactSet.
Although there is no rule that valuations can’t stay elevated, or climb even higher, some investors worry that the high price tag makes the market more vulnerable to a pullback.
And while inflation has cooled notably, easing in June to its slowest pace in more than two years, it remains well above the Fed’s 2% target. Central bank officials may not be satisfied without lifting rates again later this year or keeping them high for an extended period. And that could have unpredictable consequences.
“Everyone’s sort of come to peace with a higher fed-funds rate,” said Katie Nixon, chief investment officer at Northern Trust Wealth Management. “I don’t think we’ve quite come to grips with what the implications of staying at that level for a prolonged period of time might mean for the economy and certainly for the markets.”[/h]
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