Why stocks are rallying amid war and rising inflation

The S&P 500 has rebounded 7.6% from its 2022 lows on March 8, reducing its losses for the year to nearly 6% — higher than they were weeks ago. In many ways, investors say, the rebound has been as broad as it has been impressive, lifting everything from travel stocks to utilities to unprofitable technology companies.

A month earlier, Russia’s war in Ukraine was intensifying, causing oil prices to rise to $130 a barrel and stocks sharply lower. Kovid-19 cases started increasing again in China. Inflation data showed that pricing pressure was not easing. And in the midst of all this, the Federal Reserve began a rate-hiking cycle for the first time since 2018.

Not much has changed except that the stock is now back on the upside. Many investors are trying to understand whether the rally is the start of a sustainable rally or just a temporary respite. The broader stock market index pulled back 1.3% last week, breaking a three-week winning streak that marked its best performance since November 2020.

Here are six reasons to rebound.

History shows stocks have more room to move

Anticipation of the Fed’s March rate hike stirred volatility for months as investors braced for the unwinding of stimulus that helped turbocharge stocks. But history shows that stocks usually rise after the central bank starts raising interest rates.

In five rate-hike cycles since 1990, the S&P 500 fell a month after the first rate hike, but generally retraced those gains to rally six months later. A year later, the S&P 500 and Nasdaq Composite were up 80%, according to Dow Jones market data.

A team of strategists at JPMorgan Chase & Co., led by Marko Kolanovic, wrote in a note to clients on Monday, “The early stages of the Fed’s tightening should not be viewed as a negative for stocks, given the initial volatility.” After that equities reached new highs.” ,

Still, fears of recession are rising. Deutsche Bank’s chief US economist has warned of a recession this year, driven by aggressive tightening by the Fed. Jeremy Grantham, co-founder of Boston Money Manager GMO LLC, said Wednesday that oil price hikes like this year “have always been preceded by or triggered by a recession.”

Yet some investors are not ready to withdraw cash from the market during the recession.

“The market can go up a lot before turning into a recession,” said Mark Stokeley, chief executive officer of investment firm Adams Funds. “If you’re going to start changing your position that’s a lot of risk you’re taking on. Portfolio for an impending recession.”

Mr Stokel said that, the economic data he has seen so far does not point to a recession in the near future.

Certainly, the rate-hiking cycle isn’t always good for stocks. According to Deutsche Bank analysts, eight out of 11 cycles over the past seven decades have resulted in recessions.

For example, when the Fed began raising rates in the late 1970s and 1990s. In both cases, the major US indices ended the cycle with massive losses and soon thereafter, the economy plunged into recession.

economy still strong

Consumers are sending mixed signals about how they feel about the economy. Economic data shows that things are not as bad as fears.

US job growth remains strong, with a March report showing employers added 431,000 jobs, the 11th month in a row, an increase of more than 400,000. This marked the longest streak on record in 1939.

Investors point to other encouraging signs: Wages continue to rise. Labor Department data shows that in March, the average hourly earnings of employees on private non-farm payrolls rose 5.6% from a year earlier.

Meanwhile, US finances look healthy, which could help the economy bounce back in the face of inflation. Brian Rose, senior US economist at UBS Global Wealth Management, estimates that consumers saved about $2.5 trillion in additional savings during the pandemic.

Still, some cracks are beginning to emerge: US consumer spending slowed sharply in February from a month earlier, as inflation – which jumped at an annualized 7.9% in February – weighed on households and slashed wage benefits. I.

Actual yields are still negative

Many investors say stocks are still being picked up by a closely watched bond-market metric: real returns.

The real return is what investors receive on US government bonds after accounting for inflation. Despite the sharp rise in Treasury yields this year, so-called real interest rates are still quite low. For now, investors say it is providing support for the economy and providing an incentive for investors to seek returns in riskier assets.

According to TradeWeb, the yield on five-year Treasury inflation-protected securities—a benchmark gauge of real interest rates over the next half-decade—was minus 0.6 per cent on Friday. This was up from minus 1.6% at the end of last year, but is still well below the 1% level in 2018.

Buy Individual Investor Dip

Individual investors have helped drive the recent rise in meme stocks and stocks of unprofitable technology companies, data from Wanda Research shows.

Last month, individual investors piled on shares of the ARK Innovation exchange-traded fund, buying a net $132 million in shares, the second-highest monthly total on record and nearly three times the monthly 2021 average, data from Wanda. According to. The fund, which is run by Kathy Wood and trades under the ticker ARKK, is heavily invested in buzzy companies, some of which struggle to turn a profit.

Meanwhile, demand for bullish call options, “out-of-the-money” or far from being currently paid, recently rose to the highest level since early 2021, Wanda estimates. Bet on tech stocks like mem stock and nvidia corp. , Twitter Inc., Tesla Inc. and Advanced Micro Devices Inc. are particularly popular.

Analysts at Goldman said in a note to clients in late March that a jump in retail-trading activity helps explain gains in stocks such as nonprofit technology companies that are typically sensitive to interest rate hikes. .

“The sentiment of the most speculative segment of the retail community is becoming increasingly optimistic,” Wanda analysts wrote in an April research note.

Activity is in contrast to most of the quarter, when trading by group was reduced. Estimates from Bloomberg Intelligence show that individual investors accounted for about 17% of US stock-trading activity in the first quarter, the lowest level since 2019, before the pandemic triggered a rush of activity.

bet on corporate resilience

First-quarter earnings season begins this week, and many investors anticipate another period of strong results.

Earnings among companies in the S&P 500 are expected to increase 4.5% compared to a year ago. Although this result will pale in comparison to the blockbuster growth of the recent period, it is generally in line with the average growth rate since the first quarter of 2012.

Analysts point to one particular bright spot: Many think that US companies will be able to navigate rising inflation by raising prices. Projected net profit margins for S&P 500 companies are 12.1% for the first quarter, higher than the five-year average of 11.2%, FactSet data shows.

“At the moment, this is the relative sweet spot for equities, given that they feel comfortable with rising inflation – they think US companies retain pricing power and will not result in margin compression,” said Hugh Roberts, Head of Analytics said. Quant Insights.

a technical snapback

There are also technical factors driving the rebound. Traders and analysts said many institutional investors have aggressively dumped stocks at the start of the year.

“During the invasion … it felt like [the selloff] “All were driven by risk mitigation,” said Glenn Koh, head of global equities trading at Bank of America.

For example, Bank of America analysts forecast bearish stock conditions among commodity trading advisors, with computer-powered funds that try to bet on market trends and patterns in March before pulling back on those bets. Grow. Lately, Mr Koh said, some investors may have had to open up on bearish positions, which may have helped drive the rally.

“It felt like it was over-the-top covering,” said Mr. Koh.

—Sam Goldfarb contributed to this article.