A torrid technology-led stock market rally stalled last week as investors began to accept what the Federal Reserve has been telling them.
Bulls, however, see room for shares to continue to rise as institutional investors and hedge funds catch up after cutting or shorting stocks in last year’s tech disaster. Bears argue that a still-active job market and other factors will force interest rates even higher than investors and the Fed expect, repeating the dynamics that dictated market action in 2022.
Last week, financial market participants got closer to pricing than the Federal Reserve has been telling them: The federal funds rate will peak at 5% and won’t be lowered in 2023. Federal funds as of Friday had a top rate price of 5.17% and a year-end rate of 4.89%, Scott Anderson, chief economist at Bank of the West, said in a note.
After Fed Chairman Powell’s press conference on February 1, the market still expected the federal funds rate to peak at 4.9% and end the year at 4.4%. A red-hot January jobs report released on February 3 helped turn the tide, along with a jump in the Institute for Supply Management’s services index.
Meanwhile, the yield on the policy-sensitive 2-year Treasury note, TMUBMUSD02Y,
It is up 39 basis points since the Fed meeting.
“These dramatic interest rate moves at the short end of the yield curve are a big step in the right direction, the market has started to listen, but rates still have a ways to go to reflect current conditions,” Anderson wrote. “A 2023 Fed rate cut remains a long shot and the strong economic data in January makes it even less likely.”
The jump in short-term yields was a message that appeared to unnerve stock market investors, leaving the S&P 500 SPX,
with its worst weekly performance of 2023, while the Nasdaq Composite COMP, which had risen earlier,
broke a streak of five consecutive weekly wins.
That said, stocks are still going up smartly in 2023. The bulls are more numerous, but not so ubiquitous, the techies say, as to pose a counter threat.
In a mirror image of the 2022 market crash, previously battered tech-related stocks have come roaring back to kick off 2023. The tech-heavy Nasdaq Composite continues to rise nearly 12% in the new year, while that the S&P 500 has gained 6.5%. The Dow Jones Industrial Average DJIA,
which outperformed its peers in 2022, is this year’s laggard, up just 2.2%.
So who’s buying? Individual investors have been relatively aggressive buyers since last summer before stocks hit their October lows, while options activity has leaned more towards buying calls as traders bet on a rising market, instead of playing defense by buying put options, said Mark Hackett, chief investment officer. investigation in Nationwide, in a telephone interview.
See: Yes, retail investors are back, but right now they only have eyes for Tesla and AI.
Meanwhile, analysts say institutional investors started the new year with a lower weight than stocks, particularly in technology and related sectors, relative to their benchmarks after last year’s carnage. That created an element of “FOMO,” or fear of missing out, forcing them to catch up and take advantage of the rally. Hedge funds have been forced to unwind short positions, also adding to the gains.
“What I think is key to the next move in the market is whether the institutions destroy retail sentiment before retail sentiment destroys the institutional downtrend.” Hackett said. “And my bet is that institutions will look and say, ‘hey, I’m a couple hundred basis points behind me. [benchmark] right now. I have to catch up and being short in this market is too painful.”
However, last week contained some unwanted echoes of 2022. The Nasdaq led the way lower and Treasury yields supported. The yield of the 2-year note TMUBMUSD02Y,
which is particularly sensitive to Fed policy expectations, rose to its highest level since November.
Options traders showed signs of hedging against the possibility of a near-term increase in market volatility.
Read: Traders Brace for a Blowout as Cost of Hedging for US Stocks Hits Highest Level Since October
Meanwhile, the active labor market underscored by the January jobs report, along with other signs of a resilient economy, are stoking fears that the Fed has more work to do than its officials currently expect.
Some economists and strategists have begun to warn of a “no landing” scenario, in which the economy borders on recession, or a “hard landing,” or even a modest slowdown, or “soft landing.” While that sounds like a nice scenario, the fear is that it will require the Fed to raise rates even more than policymakers currently expect.
“Interest rates need to go up more and that’s bad for technology, bad for growth. [stocks] and bad for the Nasdaq,” Torsten Slok, chief economist and partner at Apollo Global Management, told MarketWatch earlier this week.
Read: Top Wall St. economist says ‘no landing’ scenario could trigger another tech-led stock market sell-off
So far, though, stocks have largely held up against support in Treasury yields, said Tom Essaye, founder of Sevens Report Research. That could change if the economic outlook deteriorates or inflation picks up.
Stocks have largely resisted rising yields because strong jobs data and other recent numbers give investors confidence that the economy can handle higher interest rates, he said. If the January jobs report turns out to be a mirage or other data deteriorates, that could change.
And while market participants have moved expectations more in line with the Fed, policymakers haven’t moved the goal posts, he noted. They are more aggressive than the market, but not more aggressive than they were in January. If inflation shows signs of a resurgence, then the notion that the market has factored in the “maximum shock” disappears.
Needless to say, a lot of attention is being paid to Tuesday’s release of the January Consumer Price Index. Economists polled by The Wall Street Journal expect the CPI to show a 0.4% monthly rise, which would see the year-on-year rate fall to 6.2% from 6.5% in December after peaking at about 40 years of 9.1%. last summer. The base rate, which excludes volatile food and energy prices, is expected to slow to 5.4% year-on-year from 5.7% in December.
“For stocks to remain buoyant in the face of rising rates, we need to see: 1) CPI not showing a price pick-up and 2) major economic readings showing stability,” Essaye said. “If we get the opposite, we need to prepare for further volatility.”