We have to give the stock market a great deal of credit. Following a dismal 2022 when the Nasdaq lost more than 33% of its value and the SPX 500 lost 20%, you’d never think that aggressive interest rate hikes would inspire buyers to step up. But they did – and we’ve had a great run this year. However, the signs are not looking good for the 2023 bull market.
It’s been a great year for the markets
When we turned the calendar to 2023, cooler heads finally prevailed and bullish traders dialed up winner after winner. There were plenty of worries that only a handful of Nasdaq stocks – the Magnificent Seven – were responsible for more than half of all market gains before July 4. The rest of the markets grudgingly fell in line, and both the broad Russell 2000 and the Dow Industrials surged higher. Today, the Nasdaq is up more than 30% while the SPX 500 is higher by more than 15%.
Yet all year, the Fed has been raising interest rates. The bulls argue that the Fed is close to the end of its rate hikes. They want to be prepared for a resounding rally when that happens. In the meantime, they’ll wait out any losses.
There is merit to this argument. Eventually, the Fed will cut rates back to a more neutral stance (once inflation targets are met). We don’t know when that will be, which means the bulls were taking quite a risk. Looking at the results for the first half of 2023, the strategy was an overall win for the bulls.
Is the 2023 bull market over?
But the second half of 2023 is not getting off to a good start. If rates continue to climb and the Fed exceeds its target on rate hikes, stocks may fall back to earth in a hurry.
The stock market is expensive on a relative basis versus fixed income alternatives and historical valuations. Everyone will look at earnings reports carefully. The Q2 earnings season is about 3/4 done. It has shown robust results, but the rest of the year is in question. As Fed Chair Jerome Powell said last week, the Fed is going to remain aggressive fighting inflation and may hike rates even more than promised, regardless of what the stock market is doing.
The worry of course is going overboard on rate hikes and “breaking something.” In this case, the Fed Open Market Committee would have to cut rates quickly to avert disaster. Think back to spring 2020 when the Fed was faced with this dilemma as Covid spread and caused a major panic in the economy.
Thankfully we are not there any longer, but if something doesn’t break with higher rates going forward, don’t expect to see the stock market to finish strong for 2023. In fact, a shift from equities to fixed income (bonds) may stifle stock market returns during the next few months.
