It’s only early January, but so far in 2023 the pendulum on Wall Street has swung (to paraphrase Billy Joel) from sadness to euphoria.
Stocks are off to a solid start following last year’s dismal performance. The Dow, S&P 500 and Nasdaq all rallied again Monday and each index is up between 2% and 3% since the start of the new year.
Even the CNN Business Fear and Greed Index, which looks at seven indicators of market sentiment, is now inching closer to Greed territory — after languishing in Fear mode for the better part of the past few weeks.
But why is there such optimism on Wall Street all of a sudden? The headlines still aren’t necessarily that great.
Yes, the market cheered Friday’s jobs report because it showed slowing wage growth that could lead to a further reduction in inflation pressures and smaller rate hikes from the Federal Reserve. But it also showed the pace of job growth is slowing — and that could be a precursor to an eventual recession.
Meanwhile the Institute for Supply Management’s latest data showed the services sector, a big engine of the US economy, contracted last month. And several high-profile companies in the tech, consumer, financial services (and yes, media) industries have announced big layoffs or unveiled plans to hand out pink slips. Retailers such as Macy’s (M) and Lululemon (LULU) are warning about sales and profits.
Add all this up and it doesn’t sound like cause for celebration.
But Wall Street is a funny place: Good news is often viewed as a bad sign, and vice versa.
Navigating a soft landing won’t be easy
Sure, it would be a big plus if the Fed is able to pull off a proverbial soft landing, slowing the economy without leading to a full-blown recession and/or significant decline in corporate profits. But that’s a big if.
There’s another possibility that bulls are clinging to as well: that there will be a recession, but a mild one that also just so happens to be one of the most widely expected and telegraphed downturns in recent memory. This isn’t a proverbial black swan. There is no “Lehman moment” to catch everyone off guard.
As long as the Fed can get inflation under control, investors might not be too concerned by a recession anyway. At least, that’s the ‘glass is half full’ argument.
“Any recession will be perceived by investors to be less problematic if inflation is judged to be sufficiently contained, and the Fed is prepared to mount an appropriate monetary response,” said Robert Teeter, managing director of Silvercrest Asset Management, in a report.
Teeter added that falling inflation levels should boost stocks this year “even as earnings remain lackluster.”
But others see a problem with that argument.
“Our concern is that most [investors] are assuming ‘everyone is bearish’ and, therefore, the price downside in a recession is also likely to be mild,” said strategists at Morgan Stanley in a report.
Instead, the Morgan Stanley strategists think investors might be surprised by just how much lower stocks go if there is a recession. They noted that the market may not be pricing in “much weaker earnings.”
Investors may also be underestimating how far the Fed is willing to go with rate hikes in order to make sure inflation finally starts to fall.
“Many investors have been reassured by the strength of the US labor market. Yet…the Federal Reserve is determined to tighten monetary policy until that strength is eradicated — the recession clock is ticking,” said Seema Shah, chief global strategist at Principal Asset Management, in a report.
And Shah does not believe the recession will be mild. She wrote after Friday’s jobs report that “a hard landing looks to be the most likely outcome this year.”
CNN’s Matt Egan contributed to this story.
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