- Dec. 13, 2022
-- The rally that began in mid-October stalled last week, as markets have grown more anxious over the outlook for growth in the year ahead. There is an element of irony in that the evidence of ongoing strength in the economy is the very thing that is prompting worries of economic weakness. This is not completely misplaced, given that current elevated wage gains, robust job growth, and resilient consumer-spending trends suggest the Fed's fight against inflation is not at its end, with a decline in the economy being the collateral damage from further aggressive rate hikes.
That said, it should also not be lost that markets have staged an impressive run recently, with stocks rising roughly 11% in the past two months, while bonds have also rebounded as interest rates have fallen markedly from their October peak.1. Markets are not yet convinced the Fed is nearly done hiking rates.
2. Markets are growing more anxious about the outlook for economic growth.
- The underlying trend: The relative performance between the Dow index and the Nasdaq tells the story of a market that has grown more confident that the bulk of the Fed rate hikes are behind us, but uncertainty remains around how quickly the Fed can reach a pause point. The technology-heavy Nasdaq has underperformed this year, down nearly 30% year-to-date, while the Dow is about 7% lower, as rising rates have been more punitive for high-valuation, growthier, longer-duration assets.
3. The recent market rally has been healthy, but with cautious DNA.
- The underlying trend: The S&P 500 Index (large-cap stocks) has outperformed the Russell 2000 Index (small-cap stocks) during this rebound, telling us that while investor sentiment has improved, it's not being driven by rising optimism around the economy. Small-caps tend to be more sensitive to the trajectory of economic activity, whereas large-cap companies often have more diverse revenue streams and potentially more levers to pull to manage expenses.
- The underlying trend: Although the rally has been helped by glints of optimism, it's also contained a dose of skepticism, as reflected in the outperformance of defensives over cyclicals. This trend has been at play for much of 2022, despite the boost cyclicals have received from gains in the energy sector. This is not particularly surprising, as inflation and earnings-growth uncertainties raise the appeal of areas that offer pricing power and more predictable revenue streams. Defensive leadership doesn't have to undermine the broader market. In fact, this indicates that there is still a fair amount of worry embedded in the investment backdrop – and markets often climb walls of worry.