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“It’s a mistake to assume we’re really off the hook,” says one strategist.
Johannes Eisele/AFP/Getty Images
Perhaps the best noise canceling headphones are the ones the market is wearing this year. It is better to hope that the Federal Reserve does not rip them off, because stocks may not like what they are forced to listen to.
For now, investors can’t hear or see much harm. THE
S&P 500 Index
advanced 0.7% last week, and the
Dow Jones Industrial Average
rose 2.1%, extending its winning streak to 10 days. Only the
Nasdaq Compound,
down 0.6%, lost ground.
With the latest gains, the S&P 500 is up 18.2% in 2023, amid fears of recession, mixed economic data, banking crisis and political instability. Earnings season, which continues, appears to be going well for unnamed companies
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(symbol: TSLA) or
netflix
(NFLX). At this point, the Fed might be the only thing capable of stopping the momentum.
Not that Wall Street is worried. It is almost a given that the central bank will raise interest rates by a quarter of a percentage point at its July 25-26 policy meeting, after pausing rate hikes last month. Expectations for a September hike stand at just 16%, according to the CME FedWatch Tool. If the Fed confirms the accuracy of this view, the market could continue its upward run.
The Fed, however, might not see it that way. Yes, inflation is at 3%, compared to a peak of 9.1% last year, which is a good sign. But core inflation is at 4.8%, well above the Fed’s 2% target, and the labor market has yet to show lasting signs of a slowing economy. For all the big business layoff headlines earlier this year, jobless claims fell to 228,000 in the week ended Thursday, from 237,000 the previous week. If the Fed signals that it still has work to do, it could drive the markets lower.
“People become comfortable, confident and complacent,” says Michael Darda, chief market strategist at Roth MKM. “It’s a mistake to assume we’re really out of the woods.”
And even if the market comes out of July unscathed, there is still August and the Fed’s annual Jackson Hole Economics Symposium at the end of the month. Last year, Fed Chairman Jerome Powell’s remarks in Jackson Hole spooked markets by warning that financial tightening would cause “some pain” for households and businesses. This pain was felt in the market: the S&P 500 fell 19.4% in 2022.
Few economists and market watchers expect Powell to be so hawkish now that inflation has fallen from last year’s highs, but his upcoming comments could still cast a chill. “While some market consolidation makes sense given the growing odds that financial conditions have eased too much, we would not aggressively press this trade now,” writes Dennis DeBusschere, chief market strategist at 22V Research. “The Fed has a chance for a soft landing, and it’s likely to go there.”
That’s one of the reasons Nicholas Colas, co-founder of DataTrek Research, remains optimistic, despite signs that Big Tech, the engine of this year’s rally, may be losing momentum. With the S&P 500 rising sharply this year, some investors may choose to take profits and stay out of the rest of 2023. Others may simply switch from high-flying tech names to cyclical stocks, such as financials. This could make for a good trade, and a rotation is usually a bullish signal.
But because tech is such an outsized part of the market, these other stocks would need to post huge gains to move the index significantly in the second half of the year. “If Big Tech is down 10%, you need everything else to go up even more,” Colas said.
The economy might have something to say about the market recovery. Equities appear to have brushed off the potential for a recession, despite the onslaught of hot and cold economic data. It’s enough for Tesla CEO Elon Musk to complain that “one day it looks like the world is falling apart and the next it’s all good,” before acknowledging that he “don’t know what’s going on.”
The data suggests that the possibility of a recession should not be ignored. The leading indicators index, for its part, has fallen for 15 consecutive months, which has always led to a slowdown. That’s consistent with the yield curve, which has been inverted for almost a year – a recession prognosticator for sure. “We have a really persistent signal in the yield curve,” says Roth MKM’s Darda. “It would be unprecedented not to have a recession.”
And that would surely stop the music, unless the Fed did it first.
Write to Carleton English at carleton.english@dowjones.com