Ya know when you were a kid and asked your parent or caretaker for something you really wanted, but knew it wasn’t a definite yes? So when you asked, with pretty pleases, said parent or caretaker goes through a line of questioning, hands out stipulations, and then finally says, “OK, but remember what I said!?”
That was DJ Powell’s Fed session last week on Wednesday. In my view, the market and its participants were just waiting on the yes. “Yes, we know there is still inflation, and yes, we know you can still raise rates, but can we please hear you say things are on the right track and it’ll all be OK?”
During the Q&A, he seemed to finally bend — at 2:35 p.m. ET, to be exact. In answering a question, the Fed Chair said that we may be able to reduce inflation without a significant decline in employment and growth and the crowd — or the market in this case — went wild and upwards, closing out a strong day (see chart below).
I completely understand the excitement — like when you ask for the car keys the first time or the first time you’re allowed to go somewhere alone. Then, add in a well-received earnings report from Meta — which still carries a decent weight in the S&P 500 Index — falling 10-year interest rates (see chart below), along with falling Fed rate expectations, and a market that crosses a technical upper resistance*, and you get a recipe for another bull market day (hello, Thursday of last week).
Then, to take it home, Friday’s unemployment report blew it out of the water, showing the US economy added 517K jobs in January, way more than the 188K expectation and up from 223K last month. To put this in context, the average job gains from 2010 to 2020 was 184K per month. Job growth in January was also widespread, led by gains in leisure and hospitality (though some of it was from a return of workers on a strike). Wage growth wasn’t too hot (good for the inflation picture) and the participation rate even ticked a bit higher. Wow.
Is there a but? Well, isn’t there always one?
Through Friday of last week, the S&P had given us about a year’s worth of returns in one month (up over 6%). And there’s lots of research out there that says the market has the wind to its back and that isn’t necessarily sustainable. For example, some are saying there’s been a “January effect,” which is the hypothesis that in January, stock market prices have the tendency to rise more than in any other month following a year-end sell-off that includes tax-loss selling. Others have pointed to some forced buying of short positions by those who were very bearish coming into the year and are now facing a rising market. If these two things are true, then we are probably at the end of their support. For me though, with the larger-than-average daily moves upward last week, I couldn’t shake the feeling the market just really wants to rally and could end up getting ahead of itself. As if you finally got access to the car and said you’d be right back, but couldn’t help yourself and ended up coming back hours later. Case in point: Powell gave a speech yesterday, admitting we were in disinflation — and again the stock market went wild (up).
Some now expect a greater probability of rate cuts this year — but I don’t agree. I believe the Fed will actually pause — “a Powse” — rather than cut rates this year. And with the strong employment report, it really does give the Fed more leeway** to hike more than expected right now. Plus, valuations, the price of the market relative to expected earnings (Forward P/E), seem stretched for right now, and certainly higher than the longer-term historical averages, in light of a higher interest rate regime.
That’s not to say things aren’t better than last year. Many things that were in the market’s way are better for sure (likely fewer rate hikes to come, inflation is down in some places, the Russia/Ukraine conflict seems to be economically contained). But that also seems to be priced into the markets now. I’m not super bearish… just not bullish in the very near term.
Which is all the more reason to always know your time horizon and your own ability to handle risk, try to stay invested relative to your plan, and aim to be diversified. These things can help get you through uncertainty.
*The market, as measured by the S&P 500, had been showing a resistance to rising above the 4100 level on the index. However, it did just that on Thursday, not only breaking the level but also showing up as a “golden cross”. A golden cross, when the 50-day moving average of the index rises above the 200-day moving average, is perceived as bullish.
**They may have more leeway because the Fed has a dual mandate of keeping inflation in check and supporting job growth. With such strong job data, they seem to be able to focus solely on pressuring inflation down.
Chart Sources: Robinhood Financial, Bloomberg