The Stock Market Is in the Mood to Rally, Even if It Defies Logic

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Oh, what a difference a few simple words can make.

“The disinflationary process has started,” said Federal Reserve Chairman Jerome Powell at Wednesday’s press conference, and with that, the stock market took off, as investors priced in a lower peak for the federal-funds rate and greater odds of rate cuts in the second half of 2023. Even unimpressive earnings reports from Big Tech firms and a red-hot jobs report on Friday couldn’t really dent the rally.

For the week, the

S&P 500
rose 1.6%, the

Dow Jones Industrial Average
slipped 0.2%, and the

Nasdaq Composite
trounced them all with a 3.3% surge. It’s on the verge of entering a bull market, up nearly 20% from its Dec. 28 low.

One thing the jobs data confirmed is that it’s tough to see a recession, no matter how hard you squint. The release on Friday morning showed that the U.S. economy added a seasonally adjusted 517,000 nonfarm payrolls in January, more than doubling the job growth expected by economists. The unemployment rate at 3.4% is at a nearly 54-year low. Despite that, average hourly wages increased by 4.4% year over year, slower than the 4.8% increase through December. That’s a promising sign that salary growth can slow without widespread job losses—and an economic slowdown.

There’s still a big disconnect in the market’s logic. If the labor market and the economy hold up, then the Fed would probably not feel inclined to lower interest rates in the back half of 2023, as futures pricing implies. It might take some real deterioration in the economic data to spur the central bank into action. In other words, it’s hard to see a scenario aside from rates staying higher for longer—lifting bond yields and putting pressure on stock valuations—or growth disappointing, dragging down earnings.

Don’t tell the market that. Right now, all it sees are easing financial conditions, an economy in good shape, and moderating inflation. So much so that the year-to-date rally has been driven solely by optimism in the form of expanding valuation multiples. The S&P 500’s price/earnings ratio is up 8% this year even though earnings expectations have declined by 1%. The mood is decidedly risk-on, and then some: Small-caps are outperforming large and growth is beating value. The

ARK Innovation
exchange-traded fund (ticker: ARKK) is up 42% in 2023.

Investors need to get picky, says Evan Brown, head of multi-asset strategy at UBS Asset Management. He went into 2023 expecting no recession, pointing to U.S. labor-market strength, improving conditions in Europe and China, and U.S. consumers and businesses that are less sensitive to interest rates than a decade ago. His forecast isn’t for lightning-fast growth, but for a global economy that merely hangs in.

Brown expects the Fed to pause rate hikes in the coming months and keep interest rates higher for longer. That should keep a lid on the S&P 500’s P/E multiple, and favor value-oriented stocks. The overall picture leaves Brown not quite bullish, not quite bearish, at least as far as the index level is concerned. “You’re better off picking your spots,” he says.

Wherever they may be.

Write to Nicholas Jasinski at [email protected]