Why the stock market’s “FOMO” rally stalled and what will decide its fate

A torrid tech-led stock market rally stalled last week as investors began to understand what the Federal Reserve had been telling them.

The bulls, however, see room for stocks to continue their ascent as institutional investors and hedge funds look to catch up after cutting or shorting stocks in last year’s tech disaster. Bears contend a still warm job market and other factors will force interest rates even higher than investors and the Fed expect, repeating the dynamic that dictated market action in 2022.

Financial market participants last week got close to the price of what the Federal Reserve told them: the federal funds rate will peak above 5% and will not be cut in 2023. Federal funds futures as of They were pricing in a peak rate of 5.17% and a year-end rate of 4.89% on Friday, Scott Anderson, chief economist at Bank of the West, said in a note.

Following Fed Chairman Powell’s Feb. 1 press conference, the market still expected the federal funds rate to peak just below 4.9% and finish the year at 4.4%. A scorching January jobs report released Feb. 3 helped turn the tide, along with a jump in the Institute for Supply Management’s services index.

Meanwhile, the policy-sensitive 2-year Treasury note yield TMUBMUSD02Y,
has jumped 39 basis points since the Fed meeting.

“These dramatic interest rate moves at the short end of the yield curve are a big step in the right direction. The market has started to listen, but rates still have a long way to go to reflect current conditions,” Anderson wrote. . “A Fed rate cut in 2023 is still a gamble and robust economic data for January gives it even less chance.”

The jump in short-term yields was a message that seemed to rattle stock market investors, leaving the S&P 500 SPX,
with its worst weekly performance of 2023, while the previously surging Nasdaq Composite COMP,
he had a streak of five consecutive weekly earnings.

That said, stocks are still on the upside into 2023. Bulls are becoming more numerous, but not so ubiquitous, technicians say, that they pose a contrarian threat.

In a mirror image of the 2022 market meltdown, previously-defeated tech stocks are roaring back to start 2023. The tech-heavy Nasdaq Composite remains up nearly 12% into the new year, while the S&P 500 has gained 6.5%. The Dow Jones Industrial Average DJIA,
which outperformed its peers in 2022, is this year’s laggard, up just 2.2%.

So who’s buying? Individual investors have been relatively aggressive buyers since last summer, before shares hit their October lows, while options activity has leaned more towards buying calls as traders bet on a market rise, rather than defend by buying puts, Mark Hackett, national research investment chief, said in a telephone interview.

See: Yes, retail investors are back, but right now they only have eyes for Tesla and AI.

Meanwhile, analysts say institutional investors have entered the new year underweight stocks, particularly in technology and related sectors, relative to their benchmarks after last year’s carnage. This created an element of “FOMO”, or fear of missing out, forcing them to catch up and squeeze the rally. Hedge funds have been forced to close out short positions, also boosting gains.

“What I think is the key to the next move in the market is: Do institutions destroy retail sentiment before retail sentiment destroys institutional downside?” Hackett said. “And my bet is that institutions will look and say, ‘hey, that’s a couple hundred basis points behind mine [benchmark] Right now. I have to catch up and being short in this market is just too painful.”

Last week, however, contained some unwelcome echoes of 2022. The Nasdaq led the way on the downside and Treasury yields soared. The yield of the 2-year note TMUBMUSD02Y,
particularly sensitive to expectations on Fed policy, it rose to its highest level since November.

Options traders have shown signs of hedging against the possibility of a short-term spike in market volatility.

Light: Traders brace for an explosion as the cost-of-protection for US stocks hits its highest level since October

Meanwhile, the warm job market highlighted by January’s jobs report, along with other signs of a resilient economy, are fueling fears that the Fed may be working harder than even its officials currently expect.

Some economists and strategists have begun to warn of a “no landing” scenario, where the economy avoids a recession, or “hard landing,” or even a modest slowdown, or “soft landing.” While that sounds like a pleasant scenario, the fear is that it would require the Fed to hike rates even higher than policymakers currently expect.

“Interest rates have to go up and that’s bad for technology, bad for growth [stocks] and bad for the Nasdaq,” Torsten Slok, chief economist and partner at Apollo Global Management, told MarketWatch earlier this week.

Light: Wall St. top economist says ‘no landing’ scenario could trigger another tech-driven stock market sell-off

So far, however, stocks have largely held their own against a backup in Treasury yields, noted Tom Essaye, founder of Sevens Report Research. That could change if the economic picture deteriorates or inflation rebounds.

Stocks have largely resisted rising yields because strong jobs and other recent data give investors confidence that the economy can handle higher interest rates, he said. If the January jobs report turns out to be a mirage or other data deteriorates, that could change.

And while market participants have moved expectations more in line with the Fed, policymakers haven’t moved the goalposts, he noted. They are more aggressive than the market, but no more aggressive than they were in January. If inflation shows any signs of picking up, then the idea that the market has factored in “peak aggression” goes out the window.

Needless to say, there is a lot of attention on Tuesday’s release of January’s consumer price index. Economists polled by The Wall Street Journal expect the CPI to show a monthly rise of 0.4%, which would see the year-on-year rate fall to 6.2% from 6.5% in December after hitting a high of around 40 years of 9.1%. last summer. The base rate, which excludes volatile food and energy prices, is expected to slow to 5.4% year-on-year from 5.7% in December.

“For stocks to remain buoyant in the face of rising rates, we need to see: 1) the CPI does not show a price rebound and 2) key economic readings show stability,” Essaye said. “If we get the opposite, we need to prepare for more volatility.”

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