Many investors are still nursing losses for the year. But stocks have come roaring back to life in the past few weeks thanks to hopes that inflation might be really peaking and that the Federal Reserve will soon reduce or slow down its interest rate increases as a result. Wall Street is now, dare we say, almost giddy.
The CNN Business Fear & Greed Index, which looks at seven indicators of market sentiment, is even showing signs of Greed and is not far from Extreme Greed levels. It’s a stunning turnaround from just a month ago, when the index was in Extreme Fear territory.
Why the big change in the market’s mood? Clearly, investors are banking on smaller rate hikes.
“Investors are taking the view that we are pretty much at peak inflation and peak rates,” said Nicholas Brooks, head of economic and investment research at ICG. Brooks said that even though the Fed may still need to boost short-term interest rates, longer-term bond yields have started to fall and may continue to do so.
Mostly solid third quarter earnings reports (with tech stocks being a notable exception) have helped boost traders’ moods as well.
Analysts are also currently expecting decent, if not spectacular, earnings growth of about 6% in 2023, according to estimates from FactSet Research.
The FTX bankruptcy and crypto meltdown also aren’t having a big impact on the broader stock market…even though shares of Coinbase and bitcoin miners such as Marathon Digital (MARA) and Riot Blockchain (RIOT) have plunged. So there may be contagion in crypto, but it’s not spreading to the rest of the financial sector or overall economy.
Too far too fast for the market rally?
But there are concerns that the sharp snapback in stocks may be overdone. For one, Brooks thinks that profit projections are too rosy, especially if the Fed’s rate hikes eventually lead to an economic downturn.
“Consensus earnings forecasts still seem pretty high if we’re likely going into a recession next year. So there is still a leg down for estimates,” he said.
Others point out that investors may be overreacting to the latest inflation data. While it’s true that the 7.7% increase in annual consumer prices through October and 8% rise in year-over-year producer prices were both lower than expected and smaller than the September price spikes, these are still historically high inflation numbers.
Because stocks plunged between January and September, some investors may now be rushing to buy based on the (perhaps erroneous) hope that the worst is really over.
So there’s is an almost frantic frenzy to get back into stocks.
“The market’s reaction to a modest improvement in producer price inflation reflects a fear of missing out (FOMO) on a year-end rally on the part of faster-moving institutional investors, who have reduced their risk exposure significantly this year,” said Mark Haefele, chief investment officer at UBS Global Wealth Management, in a report.
With that in mind, Haefele said he thinks there is potentially more downside for markets over the next three to six months.
There still are some bargains in the market, though, especially with smaller and mid-sized companies. Investors just need to have the stomach for the occasional bouts of market volatility.
George Young, a portfolio manager with Villere & Co. said he’s bullish right now on smaller companies, since they aren’t as widely held as the mega cap blue chip market leaders. It’s more difficult to find bargains with these larger companies, Young said.
Young also noted that the US economy seems to be in better shape than others around the world, particularly Europe. That should benefit companies that have less exposure to global markets and more of a domestic focus.
“We’re looking more for opportunities in the small and mid-cap world, companies that aren’t as well-known. Everyone wants to own and already owns Apple, Microsoft and Amazon,” he said.