What do the increases in the stock market indicate?

•  Hadar.Goldberg

•  Mar 05 2023
 

After weathering the Great Recession, indications of inflation control and the Federal Reserve nearing the conclusion of its interest rate hike cycle are expected to boost investors' confidence, who eagerly invested in stocks, leading to an increase in indices. However, it remains to be seen if the economy has truly reached a stable point or if it's just a temporary reprieve after a turbulent year in the markets.

Since the start of 2023, the stock market has been infused with positivity, as demonstrated by the Nasdaq's 15% surge, a notable improvement from its 33% drop in the previous year. Similarly, the S&P 500 has increased by 7.73% and the Dow Jones has seen a 2.4% rise in 2023. These gains have been observed despite mixed financial reports from major companies like Apple, Amazon, and Google, which were met with varying degrees of disappointment. Nevertheless, these reports did not significantly affect the weekly increases in the indexes, with Apple's stock even experiencing growth despite the company's revenue projections for the upcoming quarter being lower than expected for the second consecutive time. While Amazon and Alphabet did see a decline in their stock prices, it was not as severe as in 2022, as their shares settled for single-digit losses, which is a vast improvement from Meta's 30% plummet precisely one year ago when it announced a similarly underwhelming financial report and outlook.

Resilient market ascent

The market's determination to ascend is further evident in its relatively muted response to the surprising unemployment figures released on Friday. In January, the American economy added 500,000 jobs, exceeding the expected 187,000 job increase and causing the unemployment rate to fall to 3.4%, the lowest it has been since the 1960s. A year ago, such data would have caused significant losses of 2% or more on Wall Street. However, even with such a significant deviation from expectations, it appears that inflation has yet to be reined in, and the American economy remains heated, with wages continuing to rise, indicating another potential interest rate hike. Despite this, the S&P 500 only experienced a 1% decline, and the indexes ultimately closed out the week on a positive note.

There are two conflicting viewpoints regarding the current state of the market. The first, referred to as the "soft landing camp," asserts that the Federal Reserve has successfully managed to control inflation without leading to recession or unemployment. While inflation remains below the target rate of 2%, even prominent economists like Janet Yellen and Paul Krugman are beginning to suggest that the recent inflation may have been a result of one-off pressures from the COVID-19 pandemic, as the Fed initially believed. On the other hand, the opposing camp claims that this is simply a classic bear trap, wherein the investing public, eager for positive results following a challenging year in the markets, returns to buying shares, only to be met with a bearish downturn shortly afterward. This group believes that in the long-term, the January gains will appear as a small "blip" on the descending graph of the indices once the true effects of the recession become apparent.

Interestingly, there is a common factor that ties all these recent events together: many young people who enjoyed unprecedented profits from the stock market during the pandemic have suffered significant losses and are now returning to the labor market. This is one possible explanation for the strength of the labor market. Additionally, this trend is reflected in the segmentation of the labor market - the leisure and hospitality sector, which is more closely associated with younger workers, saw the sharpest increase in new jobs, with 128,000 positions added. The dominance of this sector in the added jobs also helps to explain why the wage increase remained moderate, in line with forecasts at only 0.3%, despite the larger-than-expected jump in new jobs. These figures are especially remarkable given that the high-tech sector experienced one of its most difficult months in January, with roughly 60,000 layoffs.

Assessing Economic Outlook

Which camp has the correct view? Even though the stock market could potentially reverse the rapid gains from January, there seems to be a different feeling in the air at present. There are increasing discussions about how the atmosphere is no longer one of anticipating a doomsday scenario, as the heavy recession that was once predicted is unlikely to occur. Currently, the macro data indicates a slowdown, which is necessary to cool down the economy. Despite undergoing eight significant interest rate hikes in under a year and the belief that the Fed is nearing the end of this process, the recession should have already materialized.

According to reports from salespeople in the field, there is a renewed interest and budget for purchasing products and services, following a challenging second half of 2022. Financial reports from the last quarter of 2022, as well as predictions for 2023, are not as apocalyptic as previously feared. While growth rates are slower or even zero in some cases, this comes after two years of abnormal jumps. Although there were layoffs at major tech companies, which were only surpassed by Apple, the number of employees is still significantly larger than in 2019. Interestingly, American companies that focus mainly on the domestic market were less affected, with a reported 2.5% decrease in profits for the last quarter of 2022. However, companies with more than half of their activity outside the US experienced a sharper decline in performance, at 7.4%.

Conclusion

Both camps remain cautious and acknowledge that there may still be more negative data and rounds of cuts, but barring any unforeseen events like the escalation between Russia and Ukraine, there are growing indications that the "Doomsday" scenario can be avoided. Most of the financial reports and forecasts for 2023 from major and influential companies in the economy, including tech giants and big banks, are out, as are most of the interest rate hikes. Based on this information, investors, not just in stocks but also in bonds, are leaning towards the soft landing scenario, but it is still too early to confirm it. Skeptics point out that in 2007, when interest rates in the US were at their current level, a soft landing was also predicted and the economy was said to have reached an optimal state. This was about a year before the onset of the global financial crisis in September 2008.

Please note that the article should not be considered as investment advice or marketing, and it does not take into account the personal data and requirements of any individual. It is not a substitute for the reader's own judgment, and it should not be considered as advice or recommendation for buying or selling any securities or financial products.

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