The Stock Market Is Rallying. Will It Last?
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The stock market has had a stellar start to the year.
As of Tuesday's close, the S&P 500 index is has gained nearly 9% this year, while the Dow Jones Industrial Average is up 3%. The tech-heavy Nasdaq Composite, which saw losses of more than 30% in 2022, has gained more than 16% since the beginning of January.
Investors appear hopeful that moderating inflation could mean an end to the Federal Reserve's interest rate hikes is on the horizon. The Fed raised rates continuously in 2022 to fight spiraling consumer prices and — because higher rates tend to weigh on the price of financial assets — the stock market, bond market and crypto market all suffered. Optimists even believe the U.S. could avoid a recession despite the concerns that have weighed on investors for months.
At the same time, however, some market watchers say headwinds are mounting, and experts are divided on whether the stock market's rally will endure.
A soft landing may be priced in
Strategists from Goldman Sachs aren't convinced that stocks will keep climbing.
“There are several reasons we believe upside to U.S. equities remains limited and that the S&P 500 is unlikely to end the year substantially above our year-end target of 4000,” they wrote in a note to clients last week (as of Tuesday's close, the S&P 500 is at 4,164 points).
Goldman’s strategists say the stock market has already priced in a soft landing for the economy — what many view as a best-case scenario that means the Fed avoids causing a recession — and add that they predict interest rates will keep rising.
Combine that with the fact that corporate earnings aren’t expected to see much growth this year, a possible debt default, and the fact that assets outside of the U.S. stock market — like cash and international stocks — are gaining popularity, and you have a recipe for more U.S. stock market doldrums in 2023, according to Goldman's experts.
A strong labor market could hurt stocks
The Federal Reserve has been rapidly raising interest rates over the past year in order to cool the economy and curb inflation. One consequence of those hikes, experts and officials repeatedly warned, would be pain in the labor market and higher unemployment.
But that hasn’t happened. Data released last week showed that the U.S. added 517,000 jobs in January, more than double what experts expected. Those jobs brought the unemployment rate down to 3.4% — it’s lowest level in more than 50 years.
While continued resilience in the jobs market is good for stocks in the near term, John Lynch, chief investment officer for Comerica Wealth Management, says it could “limit the Fed’s ability to restrain financial conditions in their battle against longer-term inflationary pressures.”
In other words, a strong jobs report can actually be bad news for investors, since it may prompt the central bank to raise rates even higher, or for even longer, to make sure the economy doesn’t overheat, putting downward pressure on stocks.
“A strong jobs market allows the Fed to lean into high rates more in order to get inflation down, and this could put the brakes on what’s been a growth-fueled market rally,” Callie Cox, U.S. investment analyst at eToro, said in email commentary shared with Money.
On Tuesday, Federal Reserve Chair Jerome Powell indicated that the central bank may be forced to raise rates higher than investors are expecting if labor market or inflation data remains hot.
Even if the market’s rally continues, investors should prepare for a bumpy ride.
"We do think this rally can last, though perhaps not without some volatility along the way,” Ross Mayfield, investment strategy analyst at Baird, tells Money, pointing to less-than-ideal earnings reports and the ongoing debate over the debt ceiling.
“Altogether, markets might be a bit overextended in the near-term and ripe for a pullback,” he adds. Over the longer term, Mayfield says a strong labor market, China’s reopening, a strong services sector and other factors point to a softer landing for the economy, and that bodes well for the market’s rally.
Even in a volatile market, financial advisors generally recommend sticking with a long-term investing strategy. Investors are notoriously bad at timing the market, and making drastic changes to your investments based on short-term market fluctuations could mean you lose out on big returns further down the road.
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