Stock Market

Steady Ascent: S&P 500 Near Record Highs Amid Market Realignment

In an often volatile and unpredictable market, the past six weeks on Wall Street have unfolded in a manner resembling what many would consider an ideal adjustment for a market that had previously ascended too rapidly. After a remarkable surge that saw a 28% increase from the correction low in October to a record peak by the conclusion of the first quarter, the S&P 500 appeared overextended, with indicators pointing to a market that was overvalued and perhaps excessively endorsed by investors.

However, as if on cue, the stock market moderated, correlated with rising Treasury yields spurred by persistent concerns over inflation. This resulted in a much-needed correction, with a conventional 5-6% pullback in stocks that tempered the overheated conditions. Contributing to this shift were a blend of factors that included cooling inflation figures, signaling of a less tight labor market, a reassuring tone of patience emanating from Federal Reserve Chair Jerome Powell, and a batch of earnings reports that largely reaffirmed expectations for year-long profit growth.

Only three weeks ago, the signs of such a pendulum swing in market sentiment seemed imminent, accompanied by suggestions that the Personal Consumption Expenditures (PCE) inflation reading might forecast a potential narrative shift toward a less aggressive monetary stance. Fast forward to recent days, and indeed such a change seems to have taken hold, with the PCE now reflecting the less hawkish direction the market had begun to anticipate.

This change in dynamics has not gone unnoticed, as the S&P 500 once again ascends, now within a mere 1% of its previous zenith on March 28. Supporters of the bullish market stand confirmed in their optimism by robust market breadth, a synchronous rise in global indices, and the overcoming of technical obstacles, such as the ease with which the S&P 500 surpassed its 50-day moving average last week.

The resurgence of the S&P 500 above the 5200 threshold has differed in its nuances from the previous instance, and the direction the market takes from here hinges largely on the forthcoming inflation data, as well as the implications of a potentially waning consumer enthusiasm.

Since the last market apex on March 28, the finance sector has surged ahead of the S&P 500 benchmark by a whole percentage point, whereas the technology domain has trailed at a similar rate. It's not been smooth sailing for all, however, with the consumer discretionary sector underperforming notably, indicating consumer demand is easing and a sensitivity to value is becoming more pronounced, as gleaned from recent earnings reports.

According to the Citi US Economic Surprise Index, there's a noticeable dip below zero for the first time in over a year, meaning that economic indicators are generally falling short of economists' expectations. Nonetheless, the overall market has been resilient, likely due to the belief that reduced consumer spending could assist in the Fed's primary mission to cool inflation.

The commonly held view that 'bad news is good news' for the market doesn't frequently hold up to scrutiny, as it solely applies under specific conditions, such as when policy is deemed excessively stringent and minor economic hiccups are unlikely to trigger a major downturn. And yet, as Citi U.S. equity strategist Scott Chronert points out, there's a possibility that the notion of 'bad news is almost good news' might be gaining some credibility again.

Chronert observes the changing correlation between the S&P 500 index and the Citi Economic Surprise Index, which hints at a growing ambivalence towards economic overperformance possibly threatening the narrative of a 'soft landing' — a condition believed necessary for further market advances given the current high valuations.

Another pillar of strength for the market has been the consistent delivery of corporate earnings that have either matched or surpassed expectations. Fidelity Investments’ Global Macro Head Jurrien Timmer has visualized the trajectory of S&P 500 earnings and their predictions through each year, revealing that prospects for 2024 are comparatively robust.

When the S&P 500 stood at comparable levels during late March, the forward-looking price-to-earnings (P/E) multiple rested at 21. With the advancing timeline, improved earnings reports, and incorporated profit forecasts, this ratio has now slightly decreased to 20.4. Meanwhile, Treasury yields have oscillated, currently sitting at around 4.5%, a modest increase from late March's figures which mostly stayed below 4.3%.

As the market grinds forward, the upcoming Consumer Price Index (CPI) and Producer Price Index (PPI) releases, along with the bond market's response to them, will heavily influence whether the market can maintain its tranquility.

Fed Chair Powell's stance appears unshaken, with a high threshold set for any policy tightening. The stationary Federal Funds Rate, coupled with an expanding economy and sporadically declining inflation, suggest a well-balanced policy environment.

Despite the steadiness, skepticism over the rally's durability persists. Election-year patterns warn of potential volatility leading up to Memorial Day, followed by some reprieve in the summer months. The recent rebound, although extensive, exhibits an irregular leadership array—comprising financials, defensive stocks, industrials, and notably utilities, which saw a strong mean-reversion bounce—fostering forced interpretations linked to AI-driven power demands.

Memories still linger from the previous summer when a rally peaked in late July, setting off signals similar to the current market's "overdone" status just as it did in late March. What followed was a measured three-week 5% downturn, a bounce back above the 50-day moving average, and thereafter, a surge in Treasury yields that unsettled the market until a more significant 10% retraction was finalized in October.

Today's global economic climate, the Federal Reserve's posture, and inflation figures are somewhat more congenial, leaving no assurance that we're in for a mere repetition of the past.

An absence of stress within credit markets and a non-threatening volatility structure further imply a composed financial market landscape. However, some argue that the market retracement seen in April might lack the depth necessary to set the stage for a robust break above previous highs.

Lori Calvasina, head of global equity strategy at RBC Capital, marks a note of caution. She emphasizes that based on their indicators of investor sentiment – like retail-investor surveys and positioning in index futures – there might be an insufficient decline to declare the current market pullback complete.

She contends that the recent 5% decline in the market might not have sufficiently "pulled back the slingshot" to empower the market to launch past old records forcefully. Nevertheless, it remains a bull market, where pullbacks often end less chaotically than expected, and without inducing the anxiety that would present buyers with a distinctly opportune moment for investment.

In conclusion, while the market continues its ascent toward historic highs, investors remain vigilant, parsing the incoming data against the backdrop of macroeconomic narratives and earnings performance. As Wall Street cautiously navigates through these fluctuating tides, only time will tell if the current rally has the momentum and foundation to scale new peaks or if a more calculated retreat is in store, setting the stage for the next wave of growth.