Year-End Rally?

Investors have just come through a very uninspiring three-month period which saw the S&P 500 fall 10%. But since October 27th things have been very different. The S&P bounced 6%, the Dow is up 5% and the Nasdaq is up nearly 7%. And it’s not just the Magnificent 7 (Apple, Microsoft, Amazon, Netflix, Meta, Tesla, Nvidia) that are rallying. Value stocks, mid-caps and small-caps are at long last joining the party. Why this abrupt change?

The Federal Reserve concluded its monthly policy meeting last Wednesday and chose to keep interest rates where they are. This second consecutive pause in the Fed’s rate hike cycle comes despite an upgrade in its view of the economy, which grew at a “strong pace” during the third quarter. So with stronger growth and stubborn inflation why is the Fed reluctant to continue raising interest rates? The simple answer is that they don’t want to drive the economy into recession. And they understand it will take time for higher rates to drag inflation back toward their 2% target.

At the same time, they acknowledge hiring activity is moderating and credit & financial conditions are tightening. Housing sector activity has “flattened out.”
These are clear signs that the Fed’s efforts are working. So even though Fed Chair Powell isn’t sure that interest rates are high enough to bring down inflation rapidly, he and his colleagues are “proceeding carefully.” Investors cheered this patience.

Last Friday’s job market report by the Bureau of Labor Statistics (BLS) confirmed Fed patience is warranted. The economy generated 150,000 new jobs in October, which is at the low end of the range for the past couple of years. BLS also revised September payrolls lower than previously reported. The unemployment rate ticked up to 3.9% and wage growth slowed to 4.1%. These figures aren’t terrible to be sure, but they do indicate lower demand for labor. And this is exactly what the Fed’s interest rate hikes aimed to accomplish. So it looks like we’re one step closer to victory, defined as bringing down inflation without driving the economy into recession.

Finally, the Federal Government may have picked up on a warning signal from the bond market. Recently, long-term Treasury yields spiked as traders sold off bonds. This move seems to have been partly driven by fear that government budget deficits are getting out of hand. Obviously, additional federal spending needs to be funded with additional debt, and many are worried that the government will flood the market with new bonds. So investors were surprised by a Treasury Department announcement that predicted lower new debt issuance for the final quarter of this year. The immediate impact was felt as both bonds and stocks began to rally. The yield on the 10-year Treasury bond fell from 4.93% on Halloween to 4.64% today—a big move. In a market plagued by rising interest rates, some stability is a welcome change even if it is temporary.