Investors received a string of positive news last week, with several factors contributing to an optimistic outlook. The Federal Reserve decided to put a pause on raising interest rates, jobs growth remained in the Goldilocks zone, and U.S. Treasury bond issuance turned out to be less than feared.
Mixed Earnings, but Reasons for Optimism
While the earnings season has presented a slightly mixed picture, there are more reasons to be optimistic now than in recent times. S&P 500 companies are on track for a return to profit growth in the third quarter, although many of their financial forecasts fell short. This negative aspect impacts stocks, but it’s important to note that the market has largely been driven by macroeconomics rather than profits throughout 2023.
Market Trends Continue
The trends in the market appear to be consistent for now. Both stocks and bonds have experienced a surge this week, recovering from previous declines observed since late summer.
Reassuring Words from the Fed
During a press conference held on Wednesday, the Federal Open Market Committee (FOMC) confirmed the expected decision to keep interest rates steady. Jerome Powell, the Fed chairman, addressed the market’s concerns and emphasized that while the battle against inflation is ongoing, the risks are shifting. The FOMC is paying closer attention to tighter financial conditions and signs of an economic slowdown.
Positive Treasury Update
On Monday, the U.S. Treasury announced that it doesn’t require as much debt issuance this quarter as previously anticipated, thanks to improved tax receipts.
Employment Report Maintains Balance
The October employment report released on Friday demonstrated a moderate level of growth. The U.S. economy added 150,000 nonfarm jobs last month, indicating a slowdown from September’s strong hiring pace but not suggesting an imminent recession.
Stephen Stanley, economist at Santander U.S. Capital Markets, noted that there will be two more employment and inflation reports before the next FOMC meeting on December 13. While this report may not provide the final verdict on the labor market, it is likely to reinforce the conviction of Fed officials who already favor maintaining the current rate level.
A Promising Outlook for the U.S. Economy
Investors are buzzing with excitement over the recent combination of Federal Reserve statements and job reports. This has ignited hopes for a favorable scenario known as a “soft landing” for the U.S. economy. A soft landing refers to a period of gradual slowdown in growth and subdued inflation without a detrimental recession.
Bond prices have experienced a significant rally, thereby lowering their yields. This follows the Treasury’s issuance announcement and reflects traders’ anticipation of a more accommodative monetary policy by the Fed in the coming year.
Presently, interest-rate futures pricing suggests only a 7% probability of a quarter-point rate hike at the Fed’s December meeting. This is a considerable decrease from the nearly 50/50 odds just a month ago, following an impressive surge in September’s economic data. Furthermore, these pricing trends indicate a projection of almost a full percentage point in rate cuts by the end of 2024, as compared to half a point at the beginning of this week.
The yield on the 10-year U.S. Treasury note, which reached 5% in October, has declined to 4.52% as of Friday morning. This represents a decrease of over 0.4 percentage points within two weeks.
The decline in bond yields has had a positive impact on stock valuations. Recent drops in share prices have made numerous companies significantly more appealing in terms of their perceived value.
As Solita Marcelli, Chief Investment Officer for the Americas at UBS Global Wealth Management, noted on Friday, the S&P 500 index was trading at around 17 times its projected 12-month forward earnings earlier in the week. Excluding certain high-flying stocks, this multiple appeared closer to 15x. In Marcelli’s opinion, these valuations seem reasonable given the expectation of a relatively gentle economic slowdown.
Consequently, this positive sentiment has led to a broad-based rally across various sectors. At least 10 of the 11 sectors comprising the S&P 500 index have seen gains throughout the entire trading week.
Moreover, the small-cap Russell 2000 index has surged by nearly 8% since the previous Friday’s close. If this upward momentum continues, it would mark the index’s largest weekly gain since June 2020, during the early stages of recovery from the Covid-19 market downturn.
Certainly, there are many variables that will come into play before the end of 2024. However, the current market conditions seem favorable for both stocks and bonds, even though a sustainable rally may require a retesting of market lows.