Will the recent upswing in the stock market continue?
Three days before Halloween 2023 the Dow Jones Industrial Average closed at 32,417. Earlier this week the widely watched stock market index closed at 38,563. Quick math shows the price return during this three- and half-month period is roughly 19%. Leaves me wondering "why".
Could be the promise of AI, could be anticipation of better than expected corporate profits in 2024, could be anticipation of Presidential election year stock market returns which have historically tended to be above average and haven't been negative since 1952. Could be a combination of all these items.
I think however, the biggest factor driving market returns over the past couple months has been expectations for interest rates. From reading the press, listening to the TV pundits and looking at the blogs somehow it seems like investors had talked themselves into believing the Fed was going to start aggressively cutting interest rates as early as next month, and there are few, if any, things the stock market likes more than declining interest rates.
This expectation appears to have predicated on the belief that the economy would start to slow in 2024, and inflation rates would start to drop. It was further bolstered by a couple erroneous comments about interest rates made by Federal Reserve Board members, which were then backtracked (no one seemed to pay attention to the back tracks). With price appreciation of nearly 20% in just a couple months however, I think the reality is investors were rubbing their hands together in anticipation of the perfect "soft landing" where the economy gently slows but doesn't go into recession, inflation rates drop, and the Fed engages a nice comfortable cycle of lowering interest rates to begin stimulating growth. With this expectation in hand, stocks became priced for perfection. What could go wrong?
Two scenarios exist to answer this question. The first is the "good news is bad news" scenario currently dominating markets. In this situation, good real-world news like continued strong employment reports, solid retail sales and rising GDP interfere with the narrative of a soft landing, and as a result interfere with the narrative of interest rate reductions. Originally some of the more bullish prognosticators were predicting six interest rates cuts, starting in March, in 2024. With the recent employment reports and hotter than expected inflation numbers from last week however, these predictions have now moved into the realm of fantasy, and the bulls find themselves searching for new reason to be excited.
The other scenario that could interfere with a stock market priced for perfection is an actual recession. Changes in interest rates take a while to work themselves into the real economy, it's still possible the effects of short-term interest rates above 5% have yet to be fully realized, and eventually these higher rates sap the growth out of the economy. In this scenario, the Fed drops interest rates but it's too little too late as a recession, as it always does, reveals the underlying cracks in our economy. While falling interest rates may be good for stocks, recessions tend to trump rates when it comes to stock prices. It's important to remember, as cryptic as they can seem, stock prices are ultimately driven by corporate profits, and profits tend to dry up during recessions.
Federal Reserve interest rate policy is never entirely predictable, but I believe at this point the idea of six interest rates cuts, starting in March is off the table. As inflation continues to fester, and the economy continues to chug along, I think any interest rate cuts are months away, and may possibly not even come in 2024.
Which leaves us with a stock market priced for perfection. Without the elixir of falling interest rates, the market is reliant on strong corporate profits to continue driving stock prices higher. We are now three quarters through the 4th quarter 2023 earnings reports, and results thus far have been a bit "meh".
If stocks need stellar earnings or falling interest rates to keep going higher, it might be time to remind ourselves that no tree grows to the sky.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. No investment strategy can guarantee a profit or preserve against loss. Past performance is not a guarantee of future results. Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.
