Published July 29, 2022
In a bull market, investors buy the rumor and sell the news, with the selling being typically light. In a bear market like we are in now, this week showed us it is the opposite. Investors fear the news, sell stocks down on the fear, buying them back when the news, though bad, is not quite as terrible as it could be. So it was with the Federal Reserve announcement this week. The Fed raised rates the expected +0.75%, talked tough on inflation, but stocks rallied – hard. The Nasdaq had its biggest day in over two years. Why? Because Fed Chair Powell sort of hinted that he can see a day when rates don’t go up so fast. The market interpreted this “not so bad” news as being a sort of light at the end of the tunnel, blue skies ahead kind of outlook. Interest rates are not on a one-way trip to the moon. They will be flattening out. This idea matches the possible market narrative where inflation has peaked and will be coming down. The economy will slow, but not TOO much. We just might have the “soft landing” of which investor dreams are made, where the economy slows down just enough to get inflation to settle down and remove the excess demand, then we roll along without corporate earnings taking much of a hit.
This newly embraced market narrative, of which rallies are made, also notes that the next Fed meeting is not until September. In this narrative, there will be a couple of lower inflation readings between now and then as energy prices have already dropped back quite a bit, rents have flattened out their rise, and all the layoff announcements will maybe take the upward thrust off wages. This narrative suggests inflation dropping back to the 2% level by year-end; and the Fed pulling back on interest rates in the middle of next year (black bars below). Here’s where the bond market is right now, embracing either this narrative or …
A narrative where the U.S. goes into a steeper recession and the Fed has to abruptly shift to reducing interest rates to fight the recession. Either way, the bond market recently argues, interest rates have peaked, for now. Indeed, mortgage rates have already dipped, as have 10-year Treasury rates. The chart below shows 10-year U.S. Treasury yields peaking at 3.5% in June. They have fallen almost a full percentage point since then.
This pullback in interest rates has taken the pressure off growth stocks, which were being roundly discounted when rates were rising. Earnings from the major growth stocks have generally been better than investors feared. There is growing evidence, at least currently, that the stock market may have priced in a serious recession that is not going to happen. That’s what the bulls are now arguing. Since the bottom in June, that argument has increasingly gained traction.
Investors had a full plate this week with the Federal Reserve’s Wednesday meeting and earnings announcements from the largest companies in the market. Monday brought little movement in stocks. But after the bell Walmart issued a very disappointing outlook sending those shares down -9%. Walmart’s news pushed stocks lower by -1.2% Tuesday. The Wednesday Fed meeting reversed that loss and then some. Investors were encouraged that Fed Chair Powell acknowledged the weakening economic data, thinking that the Fed may pull back on rate hikes sooner than previously thought. The market also reacted positively to Powell saying that a recession does not seem to be at hand given how strong hiring has been. Stocks roared higher by +2.6% with the high-growth Nasdaq stocks seeing a full +1.5% additional bump on top of the broad market’s rise. Further padding the Nasdaq’s gains was a solid reaction to earnings from Alphabet and Microsoft. Though both companies underperformed, the results were not as bad as feared. Stocks continued their positive feelings Thursday with another +1% lift. Better than feared earnings from Apple and Amazon after the market close kept the rally moving forward Friday. Stocks gained +1.4% to bring a big month of July to a close. Stocks have now fully recovered the disastrous June losses in a stark reversal of fortune for markets.
A very strong week for stocks as the market reacted very positively to earnings from the market’s largest companies. The S&P 500 pushed higher by +4.28% while the Nasdaq 100 (QQQ) rose +4.46%. Smallcap stocks added a similar +4.31%.
Warm wishes and until next week.