For a brief moment on Friday, the S&P 500
SPX,
traded above 4,200 for the first time since August, according to FactSet data.
The short-lived triumph set off a race among stock-market gurus, who have published a flurry of research to explain what they believe has driven a rally that few on Wall Street were expecting just a few months ago.
Is it investors chasing returns? Expectations for a soft landing? The Federal Reserve quietly pumping liquidity into the market while continuing to raise interest rates? The market’s irrepressible hope that the Fed will soon change course and start cutting rates? Or is it simply a factor of the artificial-intelligence craze breathing new life into technology stocks?
To be sure, the 4,200 level has been persistently stiff resistance stretching back to last summer. Failure by the S&P 500 to sustain a push above it could set the stage for another significant retreat, analysts have warned.
At the same time, however, the market’s resilience in the face of a debt-ceiling fight that could spark a cataclysmic default has perplexed bears.
Stock-market bulls have highlighted historical data pointing to the likelihood that the market’s bounce might have more room to run — despite the potential debt-ceiling disaster that Treasury Secretary Janet Yellen and many others have warned about.
Chasing the rally
One relatively straightforward explanation for why stocks have rallied this year is that skeptical asset managers have effectively chased the market higher, driven by pressure to boost returns as their main benchmark, the S&P 500, has drifted higher.
Here’s how Tom Essaye, founder of Sevens Report Research, explained it: When 2023 began, most Wall Street traders were expecting stocks’ rally off the October lows would prove to be another short-lived bear-market bounce.
See: Why stock-market bears are inadvertently supporting a rally despite some bad news
Unfortunately for them, the market has a tendency to punish proponents of “consensus” trades like this, Essaye said in emailed commentary. The result: the S&P 500 has risen 20% off its intraday low from Oct. 13, according to FactSet data.
“For all of 2023, due to a long and substantial list of risks facing the markets, investors (especially institutional investors) have expected stocks to decline (this is backed by multiple sentiment and investment surveys from throughout the year),” Essaye said.
“But as those risks have failed to materialize, it is caused the “pain trade” to be higher as underinvested managers chase returns higher, and that is exactly why the S&P 500 hit the highest level since August last week.”
Essaye cited Bank of America’s global fund managers’ survey as one piece of evidence showing how Wall Street professionals have been too pessimistic in recent months.
The survey shows how professional money managers have clung to their cautious outlook while remaining underweight.
Central-bank liquidity
For more than a decade following the financial crisis of 2008, U.S. stocks climbed reliably higher, bolstered by central banks pumping money into the global economy and markets as they slashed interest rates and hoovered up bonds.
But around the time that stocks bottomed, the tides of global central-bank liquidity started coming back in, first abroad, then later in the U.S.
Citigroup’s Matt King blamed a handful of foreign central banks for unleashing a flood of liquidity beginning late last year, led by the People’s Bank of China.
See: The secret to stocks’ success so far in 2023? An unexpected $1 trillion liquidity boost by central banks.
More recently, others have pointed to the jump in reserve balances with Federal Reserve Banks as a sign that the Fed has quietly propped up markets and the banking system in the wake of Silicon Valley Bank’s collapse.
Reserve balances surged by roughly $440 billion shortly after SVB was taken over by the Federal Deposit Insurance Corp. And they remained nearly $300 billion higher compared with levels from the first half of March, according to the latest data released by the central bank.
“The strong performance in the stock market since the March lows has had a lot more to do with the liquidity injections that have been performed to prevent panic during today’s regional banking crisis than it does with the economic outlook, the Fed outlook or even AI,” said Matt Maley, chief market strategist at Miller + Tabak Co., in emailed commentary shared over the weekend.
Fears of imminent recession dashed
A team of strategists at JPMorgan Chase & Co.
JPM,
has repeatedly told clients that a stronger-than-expected labor market and U.S. economy have been the most important factors behind the rally in stocks.
Many investors had expected a recession to begin as early as the first quarter of 2023. That this didn’t happen has helped to prop up stocks.
“The general perception is that investor bearishness is ubiquitous, but at the same time a potential downturn isn’t seen as happening any time soon by the most, with the robust labor market cited as one of the key current supports,” said a team of global equity strategists led by Mislav Matejk, a London-based equity analyst at the bank, in a note shared with JPMorgan clients and MarketWatch.
Some 253,000 new jobs were created in the U.S. in April, surpassing economists’ expectations, while wages rose sharply, suggesting there is still plenty of demand for labor even amid some signs that the economy is slowing.
Corporate earnings also managed to surpass the expectations of Wall Street pessimists during the first quarter, even if profits for the largest U.S. companies declined for the second quarter in a row.
With the first quarter reporting season nearly over, S&P 500 companies are on track to report a blended year-over-year decline of roughly 2.2%, according to FactSet data. That is compared with expectations for a 6.7% drop.
The AI craze
The market has been unusually concentrated in 2023, with the largest megacap technology stocks driving most of the market’s gains, offsetting weakness in energy stocks, small-caps and other corners of the market.
Many of the stocks that have been the biggest drivers of the S&P 500’s gains since the start of the year are attached to companies that are at the forefront of what some analysts have described as an AI revolution. This includes stocks like Microsoft Corp.
MSFT,
Google parent Alphabet Inc.
GOOG,
and chip giant Nvidia Corp.
NVDA,
— the last of which has seen its value double since the start of the year.
Partially as a result, the 10 largest stocks in the S&P 500 have seen their value increase by 32% since the start of the year, while the rest of the index has been essentially flat, according to analysts at 3Fourteen Research.
This outperformance has inspired some wariness on Wall Street, with Bank of America chief investment strategist Michael Hartnett telling the bank’s clients that AI stocks are now in a “baby bubble.”
Where to from here?
The S&P 500 finished short of a new post-August high on Monday, but the Nasdaq Composite
COMP,
succeded where the S&P 500 failed, finishing the day at 12,720.78, according to FactSet data.
If the historical pattern holds, stocks might be heading higher, even as consumer confidence remains depressed amid fears that a recession might arrive later this year.
Ryan Detrick, chief market strategist at Carson Group, found that stocks almost always finish the year higher after rising by 8% or more during the first 100 trading sessions of the year, a milestone that arrived on Thursday.
Stocks finish the calendar year higher 86% of the time once rising 8% or more through this point in the year, Detrick found, with an average return of 10%.
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