Once more, bad news for the economy is good news for the stock market. Market experts say good news is also important.
Based on how U.S. stocks responded to this week’s flurry of mixed economic data, it looks like a summer rally is almost certain to happen.
As expected, the U.S. April CPI report from the Bureau of Labor Statistics showed that inflation slowed more than expected last month. This led to a rise in stocks this week. Core prices went up 3.6% from one year to the next. That’s still a lot more than the Federal Reserve’s 2% goal, but it’s also the lowest reading since April 2021.
Thus, investors have been able to see that “Goldilocks” is back, along with hopes that the Federal Reserve will be able to guide the U.S. economy toward a soft landing as monetary policy helps bring down inflation.
Market experts told BourseWatch that this is a great time for stocks, bonds, commodities, cryptocurrencies, and anything else that has gone up a lot this year.
An interview with Andrew Krei, co-chief investment officer at Crescent Grove Advisors, a boutique wealth management firm, told BourseWatch that risky assets have done well in the past when growth has been healthy and inflation has slowed down.
Still, investors would be foolish not to think about the many risks that could stop the rally, if only for a short time.
Even Brian Belski, the most optimistic Wall Street strategist, thinks there will be some volatility in the coming months, according to a report shared with BourseWatch on Wednesday. Belski raised his target for the S&P 500 index at the end of the year to 5,600.
Because of this, BourseWatch asked a few market strategists what they thought were the biggest threats to the rally. What they said:
Earnings season ends with a whimper
The latest quarterly earnings reporting season has been solid so far, although stocks that missed Wall Street’s expectations were swiftly punished by the market.
As of Friday afternoon in New York, 470 of the 500 companies whose shares are included in the S&P 500 had reported earnings. Of these, 78% surpassed Wall Street’s typically conservative forecasts for earnings per share, more than the 10-year average, according to FactSet data.
However, there are still a few companies left to report, and one in particular has the potential to upend the market: Nvidia Corp. NVDA, -1.99%
The chipmaker has benefited enormously from the artificial-intelligence boom, perhaps more than any other company. Now, Wall Street expects its revenue for the most recent quarter will come in at $24.5 billion, which would be an increase of 240% from a year before.
If investors’ response from the past few quarters is any indication, Nvidia needs to not just meet Wall Street’s forecasts, but meaningfully surpass them.
And if the chip designer’s results show any signs that the pace of demand for Nvidia’s products is starting to slow, the broader market will likely feel the blowback, said Steve Sosnick, chief market strategist at Interactive Brokers, in written commentary.
“If they can continue their enviable, remarkable string of beating estimates, raising guidance, then beating the raised guidance next quarter, that means that the AI trade can and will proceed apace,” Sosnick said about Nvidia.
“If there is even the slightest sign of weakness, however, much more than that stock alone will suffer.”
Economy shifts from ‘soft’ to ‘hard’ landing
There’s no question that the U.S. economy is doing fine right now. After all, the Atlanta Fed’s GDPNow services is forecasting 3.4% growth during the second quarter.
But economic data for April released so far have hinted at an incipient slowdown that could snowball, potentially threatening markets, analysts said.
The evidence can be seen in a number of different data series. For starters, the unemployment rate ticked higher last month. Also, the number of Americans applying for jobless benefits has started to climb over the past few weeks. Pair this with signs that the number of job openings are shrinking, and it would appear that the labor market is finally starting to cool.
Meanwhile, U.S. retail sales stagnated in April, while economic activity in the services sector contracted for the first time since December 2022, according to the Institute for Supply Management’s non-manufacturing PMI.
Taken together, these data suggest that for the first time in well over a year, the economy appears to be losing momentum, said Tom Essaye, founder of Sevens Report Research.
So far, this has been welcome news for economists and market analysts, but there’s a limit to how much the economy can weaken before it starts to weigh on stocks.
“While data is still pointing towards a soft economic landing, hard landing risks did rise last month,” Essaye said in written commentary shared with BourseWatch.
“That’s important for investors because an economic hard landing is one of the few ‘rally killing’ threats out there right now.”
Stocks might fall because they are too heavy.
When something is too much of a good thing, it’s no longer good.
According to Crescent Grove’s Krei, this means that as long as inflation stays above the Federal Reserve’s 2% target, a steady rise in stocks and bonds could bring back the wealth effect and inflation along with it.
To put it another way, the rally could plant the seeds of its own destruction if it goes too far.
If falling Treasury yields happen at the same time that inflation starts to rise again, Chair Powell might have to step in again and hit the markets hard, just like he did in August 2022 when he spoke at the Jackson Hole economic symposium put on by the Kansas City Fed.
Analysts say Powell could easily do this by allowing the Fed to raise interest rates again.
Since July of last year, the Federal Reserve has not raised interest rates. Chair Powell’s statement earlier this month that another rate hike was “unlikely” helped the markets react positively. Because of this, the Chicago Fed’s measure of financial conditions, which is basically a measure of how easy it is for people to get credit, has dropped to its lowest level since January 2022.
People are already talking about how the recent drop in Treasury yields seems to be causing a wild “melt up” in stocks. It’s crazy, but Michael Kantrowitz, chief investment strategist at Piper Sandler, never thought he would see defensive utility stocks trade like they were the hottest new AI play. And this week, a post from an X account that hadn’t been used in a long time started a short-lived repeat of the “meme stock” craze in January 2021.
“Maybe both the bond and stock market need to cool off for a moment, because a melt-up that gets too hot could explode,” Kantrowitz wrote in an email.
When the minutes from the May 1 policy meeting are made public next week, investors should get a better idea of how the Federal Reserve thinks about where interest rates are going. In addition to the minutes, IHS Markit will also release their preliminary PMIs for May, which will give them more information about the state of the U.S. economy’s manufacturing and services sectors.
Another report on how people feel about buying things from the University of Michigan will be the last big event on next week’s economic calendar.
For the first time ever, the Dow Jones Industrial Average (DJIA) closed above 40,000 on Friday. The S&P 500 (SPX) also came close to setting a new record, ending at 5,303.27. These two major stock market indicators capped their longest run of weekly gains since February.
The only stock that went down on Friday was the Nasdaq Composite COMP, but it still managed a good weekly gain of 2.1%.
