After a tumultuous two-year journey marked by inflation concerns and looming recession fears, Wall Street has surged to record highs. The S&P 500, a key indicator of Wall Street’s performance, rallied 1.2% to reach 4,839.81, wiping out all losses incurred since its previous record of 4,796.56 set at the beginning of 2022. During this period, the index experienced a significant drop of up to 25%, coinciding with inflation levels not seen since 1981.
The primary source of anxiety for Wall Street was not just the elevated inflation but the traditional remedy employed by the Federal Reserve: high-interest rates. The Federal Reserve rapidly increased its main interest rate from nearly zero to a range between 5.25% and 5.50%, a level not seen since 2001. Historically, such interest rate hikes have led to recessions, and Wall Street anticipated a similar outcome.
However, contrary to expectations, the current economic cycle has defied the norm. The economy continues to grow, unemployment remains low, and optimism is on the rise among U.S. households. According to Niladri “Neel” Mukherjee, Chief Investment Officer of TIAA’s Wealth Management team, the uniqueness of this cycle is attributed to the pandemic’s introduction of unprecedented elements.
Inflation, which surged due to COVID-19-related supply chain disruptions, has been gradually cooling since its peak two summers ago. The big question now is when the Federal Reserve will start lowering interest rates. Such rate cuts are anticipated to act as a stimulant for financial markets, alleviating pressure on the economy and the financial system.
Already, Treasury yields have significantly eased on expectations of rate cuts, contributing to a sharp rally in the stock market in November. The 10-year Treasury yield dropped to 4.13%, down from its October peak of 5%, the highest level since 2007.
However, some critics argue that Wall Street might be overly optimistic about the timing of the Federal Reserve’s interest rate cuts. Rich Weiss, Chief Investment Officer of Multi-Asset Strategies at American Century Investments, suggests that the market is “addicted to rate cuts” and overly focused on them.
While traders have repeatedly anticipated imminent rate cuts, high inflation has proven more persistent than expected, leading to potential market corrections. Nevertheless, this time, the Federal Reserve itself has hinted at impending rate cuts, with traders betting on a nearly 50% chance of cuts starting in March.
Encouraging data on Friday, including a University of Michigan report indicating a surge in consumer sentiment to its highest level since July 2021, added to positive market sentiment. Rising consumer sentiment is crucial as consumer spending is a key driver of the economy.
The production of “Michael,” an upcoming Michael Jackson biopic, starring Jaafar Jackson, also contributed to the positive market mood. The film, set to release in 2025, aims to portray Michael Jackson’s triumphs and tragedies on an epic scale.
Despite the market’s recent record highs, potential risks linger, including uncertainty about the timing of Federal Reserve rate cuts and the possibility of an economic recession. Interest rate hikes typically take a considerable time to fully impact the system and can result in unexpected disruptions within the financial system.
In conclusion, Wall Street’s return to record highs serves as a testament to the resilience of patient investors who diversify their portfolios across the U.S. stock market. While challenges remain, including economic uncertainties and potential disruptions, history shows that the market has historically recovered given sufficient time, emphasizing the importance of a long-term investment perspective.