Party On
Jerome Powell may want to divert his attention from the stock market, as it is defying the notion that financial conditions are restrictive enough.
The Dow Jones Industrial Average has surpassed 40,000 points on Thursday, with a six percent increase so far this year. It has risen by an impressive 23 percent since hitting a low point in October, prior to the Federal Reserve changing course on rate hikes.
Do you remember when Powell took a firm stance with the markets at the Fed’s annual event in Jackson Hole, Wyoming, in the summer of 2022? He emphasized that the central bank would persevere until the job was done, forewarned of potential challenges, and highlighted the risks of halting rate hikes prematurely over the risks of monetary policy becoming overly restrictive.
Powell even referenced Paul Volcker, illustrating how a prolonged period of strict monetary policy was necessary to combat high inflation in the past. He stated that it was crucial to bring down inflation to stable levels, a norm until recently.
“Achieving price stability may require maintaining a restrictive policy stance for some time,” Powell remarked at the event. “Past experiences urge caution against prematurely easing policy.”
Following that speech, the Dow plummeted by 1,000 points. The S&P 500 and Nasdaq also experienced significant declines. These drops were in addition to previous decreases in anticipation of the hawkish speech. By the end of the year, major stock averages recorded their worst annual performance since the near collapse of the financial system in 2008.
Interestingly, the federal funds rate was at 2.3 percent when Powell delivered his speech. This rate is now slightly over half of the current rate. However, monetary policy is not solely about the present rate but also about the anticipated trajectory of rates. Hence, despite the higher rates compared to 2022, the monetary policy stance is arguably more accommodative due to the market’s belief–shared by Powell–that the Fed’s next move would be a rate cut.
The Recession We Never Had
Since September 2022, the Dow has increased by approximately 40 percent, the S&P 500 by 48 percent, and the Nasdaq by 58 percent.
This surge was almost unimaginable a few years ago, with widespread predictions of an impending recession. The prevailing view on Wall Street was that the Fed’s rate hikes would trigger an economic downturn in 2023, and at one point, Bloomberg’s economics team pegged the likelihood of a recession in 2023 at 100 percent.
Traders work on the floor of the New York Stock Exchange on May 16, 2024, in New York City. Stock indexes surged in trading with the Dow opening Thursday near a 40,000 milestone. (Spencer Platt/Getty Images)
At Truth Voices Business Digest, we countered this narrative, questioning the Fed’s resolve to raise rates significantly. We noted that Biden’s expansive fiscal policies were sustaining excessive demand, and ample savings were fueling continued consumer spending growth. With low unemployment and abundant job openings boosting household income and confidence, we predicted no recession on the horizon.
As anticipated, the feared economic downturn did not materialize. In early 2023, the Fed signaled a slowdown in rate hikes, halting them in July. While there were hints of a possible further rate hike later, markets already anticipated a peak in rates. By the end of last year, the Fed was clearly leaning towards rate cuts.
Notably, the stock market’s current buoyancy is not solely due to the Fed’s change in direction. Many investors are optimistic about the productivity surge driven by advancements in artificial intelligence. This optimism has particularly boosted tech giants like Nvidia, whose market value surpassed $2 trillion after a 99 percent rise this year. Microsoft, in collaboration with OpenAI, rose by 13.5 percent this year, with a market value of $3 trillion. Meta shares increased by 36.63 percent, Amazon by 22 percent, and Alphabet by 26 percent. (Apple’s shares have seen a modest increase of less than three percent since the beginning of the year, partially due to a perceived lack of significant AI impact.)
Furthermore, the recent market rally is not limited to technology stocks. Industrial stocks rose by 10 percent so far this year and 28 percent over the past year. Utilities increased by 14 percent, materials by seven percent, consumer staples by over eight percent, and consumer discretionary stocks are down since the year began but up by a remarkable 27 percent over the past 12 months.
Is a Crash Looming?
The primary concern looming over the market is the potential return to Fed rate hikes due to resurging inflation. Such a scenario would likely lead to a correction in the current lofty valuations. If the market perceives a need for the fed funds rate to reach seven percent, would the S&P 500 still be trading above 20 times earnings?
However, a crash is not inevitable, let alone imminent. As emphasized in Powell’s recent speech in Amsterdam, the Fed is far from considering a return to rate hikes. It would require significant inflation escalation over many months to shift the Fed’s bias towards rate cuts. This suggests that the market could continue its upward trajectory. Additionally, the labor market remains robust, consumer spending is resilient, and the upcoming election may alleviate concerns about tax hikes and mounting regulations.
When an economy or financial market is described as “Goldilocks,” the common analogy is that the bears eventually emerge. They find evidence of Goldilocks’ intrusion but discover she has already fled. In most versions of the story, Goldilocks escapes without consequences, as everything turns out just right.
