Why The Rally?

The Dow and S&P 500 fell at the open this morning, mostly under the influence of mega-caps like Amazon (AMZN) and Apple (AAPL), both down about 2%. But much of the rest of the market—materials, industrials, financials, energy, real estate—are rallying. Commodities are also broadly higher. WTI crude oil has swung around wildly of late due to machinations by OPEC+. The only takeaway is that AAA’s national average price of gasoline has fallen back to $3.52/gallon. The bond market is mixed today. Safe-haven Treasuries, which have rallied hard during the last few weeks, are selling off. But junk bonds catching a bid.

Junk, it turns out, is a good barometer for recession fears. After all, bonds with higher risk of default should be more sensitive to general economic conditions. A widely held junk bond fund, SPDR High Yield Bond ETF (JNK), is down almost 16% so far this year. But more importantly, it seems to have bottomed last month, right about the time the stock market troughed. Since then the fund has pushed higher. And movement of bond spreads—the difference between yields of high and low quality bonds—have been positive. Does this mean the perceived risk of recession is lower than it was a month ago? Probably.

And yet, comments by a couple of Federal Reserve officials yesterday seem to suggest otherwise. Fed Bank of St. Louis President James Bullard reiterated his view that the Fed’s short-term interest rate will end up between 5% and 7% before this hiking cycle is through. He said the bond market is underestimating how high rates will go. His counterpart in New York told the Economic Club of New York that “further tightening of monetary policy” is needed to “restore balance between demand and supply and bring inflation back to 2% over the next few years.” I can’t completely reconcile this stock & bond rally with the latest “Fedspeak.” But perhaps markets had fallen so far, so fast during the first 10 months of the year that any good news—such as the expectation that the Fed will slow the pace of rate hikes going forward—can cause a rally. Or maybe investors are judging that the economy can withstand more rate hikes.

A couple of reports released this morning confirm continued weakness in the housing market. S&P’s Case-Shiller Home Price Index decelerated to a year-over-year rate of 10.4% in September from 13% in August and over 20% last March. FHFA’s House Price Index tells the same story. The outsized price gains of 2021 are now a thing of the past. While the level of home prices is still rather high, they are now stagnating. In fact, Zillow tells us that median listing prices have fallen about 4% since June.