Wall Street Returns to Record Highs After Two-Year Rollercoaster Ride
After a tumultuous two-year journey plagued by high inflation and fears of an impending recession, Wall Street has finally returned to record highs. The S&P 500, a key indicator of Wall Street’s health, surged 1.2% to reach 4,839.81, erasing all its losses since the start of 2022 when it last set a record of 4,796.56. During this period, the index plummeted by as much as 25% as inflation reached levels not seen since 1981.
The primary concern for Wall Street was not just the high inflation itself but also the Federal Reserve’s response to it. Traditionally, the Fed raises interest rates to combat inflation, which can negatively impact the economy and stock prices. In this case, the Fed rapidly increased its main interest rate from virtually zero to its highest level since 2001, ranging between 5.25% and 5.50%. Historically, such rate hikes have led to recessions, and many expected the same outcome this time.
However, the current situation has proven to be different. The economy continues to grow, unemployment remains remarkably low, and optimism is on the rise among US households. Niladri “Neel” Mukherjee, Chief Investment Officer of TIAA’s Wealth Management team, believes that this cycle is far from normal and attributes its uniqueness to the pandemic’s impact.
Inflation, which soared due to COVID-19 shutdowns and supply chain disruptions, has been cooling off since its peak two summers ago. It has eased to the extent that Wall Street’s biggest concern now is when the Federal Reserve will start lowering interest rates. Rate cuts can act as a boost for financial markets and alleviate pressure on the economy and the financial system.
Expectations for rate cuts have already caused Treasury yields to relax significantly, leading to a sharp acceleration in the stock market’s rally in November. The yield on the 10-year Treasury slipped to 4.13%, down from its October peak of 5%, the highest level since 2007.
Critics argue that Wall Street may be overly optimistic in predicting the timing of rate cuts. Rich Weiss, Chief Investment Officer of multi-asset strategies at American Century Investments, believes that the market is addicted to rate cuts and is myopically focused on them. In the past, traders have repeatedly anticipated rate cuts, only to be disappointed by stubbornly high inflation. If history repeats itself, stock prices may need to readjust.
However, this time, the Federal Reserve itself has hinted at future rate cuts, although some officials suggest they may occur later than the market expects. Traders are betting on a nearly 50% chance of rate cuts starting in March. Brian Jacobsen, Chief Economist at Annex Wealth Management, believes that the truth lies somewhere between the Fed’s statements and market expectations, causing fluctuations in financial markets until they align.
Encouraging data from the University of Michigan indicates that consumer sentiment in the US is soaring. This is crucial as consumer spending is a major driver of the economy. Additionally, expectations for upcoming inflation among households appear to be stable, alleviating concerns of a vicious cycle that could keep inflation high.
The recent surge in Wall Street was largely driven by technology stocks, which have consistently performed well. Several chip companies experienced consecutive gains after Taiwan Semiconductor Manufacturing Co. provided a better revenue forecast than analysts anticipated. Broadcom rose 5.9%, and Texas Instruments climbed 4%.
The S&P 500 closed at a record high, with the Dow Jones Industrial Average also reaching its own record a month earlier. The Nasdaq composite also experienced significant gains. However, it is worth noting that last year, only a few Big Tech companies were responsible for the majority of the S&P 500’s gains. These companies, including Microsoft, Apple, Alphabet, Nvidia, Amazon, Meta Platforms, and Tesla, capitalized on the market’s interest in artificial intelligence-related technology. While some of these stocks remain below their record highs, such as Tesla, the market has historically recovered over time.
The return of the S&P 500 to a record high serves as a reminder that patient investors who diversify their investments across the US stock market eventually recoup their losses. Although it may take time, as seen during the lost decade of 2000 to 2009, when the S&P 500 endured the dot-com bubble burst and the global financial crisis, the market has historically made investors whole again. In fact, including dividends, investors with S&P 500 index funds already reached break-even a month ago.