May 13, 2024 : Sustained US Stock Market Rally Despite Rising Interest Rates

Continued Rally Possible Amid CPI Increase

Recent positive signals and new statistics have been announced regarding the US economy. According to the US Department of Labor’s April employment report last week, new job additions fell short of Wall Street’s expectation, increasing by only 175,000. This has heightened expectations for a Federal Reserve rate cut. Additionally, initial unemployment claims reached 231,000, the highest since last August, further boosting these hopes. Consequently, the S&P 500 index surpassed 5200 once more, and at 9:30 AM EST on May 10, the New York Stock Exchange began trading with a 0.2% increase.

Surge in Semiconductor Stocks

Semiconductor stocks also showed strength. Taiwan’s TSMC reported a 60% year-over-year increase in April sales, driven by artificial intelligence (AI) demand. TSMC’s April sales surged 59.6% year-over-year and 34.3% month-over-month. As a result, by 9:50 AM, the S&P 500 index had risen to 5239.11, nearing the all-time high of 5254 set on March 28.

However, Charles Schwab cautioned that despite the initial rise following weak employment data, short-term stock catalysts are scarce, making significant increases unlikely ahead of next week’s major inflation data release. UBS echoed this sentiment, noting that the speed and scale of further stock market gains would depend on upcoming inflation data, signals from the Fed, and the final stages of the first-quarter earnings season, particularly from NVIDIA.

Decline in Consumer Sentiment Index

The upward trend did not last long. At 10 AM, the University of Michigan released its preliminary May consumer sentiment index, which fell to 67.4 from 77.2 in April, the lowest in six months. Wall Street had expected a reading of 76.

While a slowdown in consumer sentiment can be viewed positively as it may lead to reduced inflation, the survey also showed a significant rise in inflation expectations. One-year inflation expectations jumped from 3.2% in April to 3.5%, and five-year expectations rose from 3.0% to 3.1%.

The University of Michigan explained that consumer sentiment fell about 13% from the previous month, the lowest in six months, as consumers expressed concerns about inflation, unemployment, and interest rates. However, the survey had a sample size of only 600 households and recently transitioned from telephone to internet surveys, potentially increasing negative responses. Ian Shepherdson, an economist at Pantheon Macroeconomics, noted that the shift to web responses might account for slightly higher inflation expectations and downplayed the significance of this change.

RSM stated that the sharp decline in consumer sentiment appeared to be an overreaction to rising gasoline prices and overall inflation, rather than a reliable indicator of future consumption.

Stock and Bond Market Reactions

Following the consumer sentiment report, the yield on the 10-year US Treasury surpassed 4.5%, stock gains narrowed, and the Nasdaq turned negative. The S&P 500 also reversed its gains and remained flat. Brian Nick, a strategist at Nuveen, commented that the sentiment index suggested inflation was not moving in the right direction, with people becoming increasingly worried about the economy and inflation.

Market Experts’ Opinions

Several market experts weighed in on the consumer sentiment survey. Goldman Sachs noted that web-based responses tend to be more pessimistic than phone responses, but the University of Michigan reported that this negative trend appeared in both web and phone interviews this time. Ned Davis Research highlighted that the 9.8-point drop in the sentiment index, excluding the early pandemic period, had only occurred seven times since 1978, aligning with expectations of slower economic growth.

Wells Fargo remarked that May’s consumer sentiment was bleak, with the most concerning factor being the sharp rise in inflation expectations to 3.5%, reflecting consumer fatigue over persistent inflation.

Inflation Expectations from Philadelphia Fed

The Philadelphia Federal Reserve’s survey of Wall Street experts showed higher inflation expectations. Experts projected core personal consumption expenditures (PCE) inflation, the Fed’s preferred benchmark, to reach 3.0% in the second quarter, 2.5% in the third quarter, and 2.4% in the fourth quarter, significantly higher than the 2.1% forecast in the previous year’s fourth-quarter survey. Economists from Goldman Sachs, Morgan Stanley, and JP Morgan participated in this survey.

Comments from Fed Officials

Several Fed officials expressed hawkish views. Governor Michelle Bowman stated that a rate cut this year is not guaranteed, and multiple meetings would be necessary. Dallas Fed President Lorie Logan indicated uncertainty about whether the policy rate is sufficiently restrictive, and Minneapolis Fed President Neel Kashkari noted that while the bar for another rate hike is high, it cannot be ruled out. Conversely, dovish Chicago Fed President Austan Goolsbee downplayed short-term inflation expectations as a major issue.

Fed Policy and Bond Market

Interest rates closed with significant gains. By 5 PM, the 10-year Treasury yield had risen 5.1 basis points to 4.50%, and the 2-year yield had climbed 6.5 basis points to 4.872%. The S&P 500 index’s rebound to around 5200 was influenced by the stabilization of interest rates, thanks to last week’s FOMC meeting and April employment report. If the April CPI does not rebound next week, the positive bond market sentiment could continue.

Morgan Stanley emphasized that the Fed’s message was clear, predicting that the future path of the benchmark interest rate would either remain unchanged or decline. This outlook could be a positive signal for various bonds. Additionally, the Fed plans to significantly slow the pace of quantitative tightening (QT), limiting the reduction of Treasury securities to a maximum of $25 billion per month from the previous $60 billion.

Charles Schwab stated that the bond market’s sentiment improved significantly after the April employment report. The report’s results led to a shift from the belief that the Fed’s easing was difficult and further rate hikes might be necessary, to considering the possibility of a rate cut this year. This has supported bond prices since then.

Evercore ISI analyzed that seasonal factors support the decline in bond yields. Evercore pointed out that the seasonal component of the 10-year yield explained much of the year’s yield decline and subsequent rebound, suggesting that yields could fall in May and June.

Stock Market Response

Major indices gained strength again towards the end of the session. The Dow Jones closed up 0.32%, the S&P 500 up 0.16%, while the Nasdaq ended nearly flat at -0.033%. The Dow Jones marked its eighth consecutive day of gains. Semiconductor stocks also performed well, with TSMC rising 4.53% following its 60% surge in April sales. NVIDIA, Micron, Broadcom, and ARM also posted gains. Novavax skyrocketed 99% after announcing a new COVID-19 vaccine commercialization deal with Sanofi starting next year.

Overall Positive Market Sentiment

Overall, a positive market sentiment prevails. According to LPL Financial, there have been six instances over the past 35 years when the Fed maintained high rates, during which the S&P 500 rose by an average of about 13%. Since the Fed last raised rates in this tightening cycle in July last year, the S&P 500 has climbed 14% through yesterday. LPL Financial’s Jeff Buchbinder stated that prolonged pauses are generally favorable for stocks, and stocks tend to plunge only when the economy deteriorates to the point where the Fed needs to cut rates, which is not the current scenario.

CFRA raised its year-end target for the S&P 500 index from 5250 to 5610, citing the typically favorable returns in presidential election years and the benefits of the soon-to-begin rate cut cycle, indicating an additional 8.2% upside potential.

Improved Market Liquidity

Goldman Sachs reported signs of improved liquidity in the US stock market. According to Goldman Sachs, the top-of-book liquidity for the S&P 500 index reached $18 million as of May 6, up from $8 million a year ago, with liquidity more than doubling over the past two weeks. The improved liquidity is attributed to reduced volatility in US stocks, decreased hedging demand from investors, increased investor profits from market gains, and greater transparency in the Fed’s rate policy direction.

Views on Employment Slowdown

The recent slowdown in April employment and the increase in unemployment claims have raised concerns about economic slowdown. However, Yardeni Research commented that the 12-month forward earnings per share (EPS) of S&P 500 companies is an excellent indicator of employment in the private sector. Companies that are profitable hire employees, and those that are not lay them off, making this measure meaningful. Wall Street’s forward EPS forecasts hit an all-time high in April, which corresponds to a robust labor market. Yardeni Research dismissed claims that the rise in unemployment claims signals the start of a recession, labeling such forecasts as the most widely anticipated recession ever, now becoming the longest-anticipated one.

Upgraded GDP Growth Forecast

Ned Davis Research raised its forecast for real GDP growth in 2024 to 1.5–2.0% from the previous 1.0–1.5%, considering the growth so far this year. While growth remains on a slowing trajectory, it is not as severe as initially expected. The firm’s recession watch data shows that although some indicators have worsened, only one has crossed the recession threshold, indicating that the risk of a recession remains minimal for now. Summarizing, various data suggest that while total demand will slow throughout the year, the decline will be limited by inherent resilience and favorable financial conditions.

Upcoming Economic Data and Outlook

Key economic data to be released next week include April’s Consumer Price Index (CPI), Producer Price Index (PPI), and retail sales. These data are anticipated to confirm that the upward momentum of inflation has moderated somewhat. This week, average hourly wages, a key inflation indicator, were slightly lower than expected, and ISM services index prices paid dropped sharply in April, suggesting a partial stabilization of prices. If the April CPI shows an easing trend next week, it will reinforce the possibility of a rate cut within the year.