It's been "risk on" for investors in the first few weeks of 2023.
The Nasdaq has gained 9% after losing one third of its value last year.
And some of 2022’s hardest-hit trades — the very ones investors judged most vulnerable to higher interest rates — are clawing back in a big way.
Tesla (TSLA), for example, is up 30% year to date as of Thursday's close. The ARK Innovation ETF (ARKK), a bellwether for speculative tech, is up 20% in 2023. From their lows reached last year, Netflix (NFLX) shares have more than doubled.
But one Wall Street strategist isn't convinced this year's rally isn't a move we've seen before. Which could spell trouble for emboldened stock market bulls.
"So far, price action in January 2023 bears an eerie resemblance to that in July 2022, when risk assets rallied and rates fell as investors bought into the idea of a 'soft landing,'" wrote Gargi Chaudhuri, head of BlackRock's iShares Investment Strategy, in a note to clients this week. "That argument faded and price action reversed as the Fed held firm and went on to hike policy rates by 75 basis points in September."
Just like in July 2022, investors again seem convinced inflation is in the rearview mirror, and that weaker economic data will do away with any more rate hikes.
In fact, market pricing suggests investors see rates ending the year where they stand today, according to the CME's FedWatch Tool. This means investors are effectively ignoring the Federal Reserve's latest forecast published last month, which suggested interest rates would likely close 2023 at 5.1%.
"We think, just as in July 2022, that markets are misreading the outlook for inflation," Chaudhuri said, adding inflation is likely more persistent than the market hopes and pointing to still stubborn shelter costs.
The Consumer Price Index (CPI) released earlier this month showed prices rose 6.5% over last year in the final month of last year, a marked slowdown from the 9.1% high seen back in June.
But while the headline figure is down from its peak, underlying pressures remain prevalent. The cost of shelter, for example, a "stickier" component of inflation that accounts for about one-third of the total index, continued to run hot, rising 0.8% over the prior month and 7.5% from the prior year.
And Fed Chair Jerome Powell's new preferred measure of inflation — services excluding housing — rose 7.4% over the prior year in December.
"We need activity weakness to translate to job losses to address Powell’s preferred services ex-shelter inflation metric, where wages are the primary driver," Alexandra Wilson-Elizondo, head of Multi-Asset Retail Investing at Goldman Sachs Asset Management, said in recent emailed comments.
"We continue to think that we should not fight the Fed because they will demonstrate a slow reaction function on inflationary risk management."
Moreover, incoming economic data continues to show the U.S. economy remaining resilient in the face of elevated inflation and higher rates. The labor market has breezed through monetary tightening, adding 223,000 jobs in December and an average 375,000 per month across 2022. Meanwhile, data out Thursday showed gross domestic product (GDP) grew a faster-than-expected 2.9% in the fourth quarter.
"Just as importantly, markets are disregarding the consistent Fedspeak suggesting that the FOMC is more inclined to keep policy tight to ensure that inflationary pressures do not return," Chaudhuri added.
According to BlackRock data, year-to-date flows to fixed income ETFs stand at $30 billion, higher than equity ETF inflows of $16 billion. The last time this happened was, you guesse it, in July. Bond prices rise and interest rates fall, hence the argument these flows suggest the Fed will not raise rates as high as it is forecasting.
According to BlackRock data, year-to-date flows to fixed income ETFs stand at $30 billion, higher than equity ETF inflows of $16 billion. The last time this happened was, you guessed it, in July. Bond prices rise and interest rates fall, hence the argument these flows suggest the Fed will not raise rates as high as it is forecasting.
Moreover, many of Wall Street's forecasts have stocks ending the year little changed or even lower if a recession unfolds.
"We expect inflation to stay persistently high and we take the Fed at its word that it remains committed to achieving its mandate of long-term price stability (which it defines as about 2% inflation) and raise rates to between 5-5.25%," Chaudhuri wrote.
"We do not expect the Fed to ease this year, even as growth slows, making it likely that we will see a recession in the U.S. in the second half of 2023."
What to Watch Today
Economy
- 8:30 a.m. ET: Personal Income, month-over-month, December (0.2% expected, 0.4% during prior month)
- 8:30 a.m. ET: Personal Spending, month-over-month, December (-0.1% expected, 0.1% during prior month)
- 8:30 a.m. ET: Real Personal Spending, month-over-month, December (-0.1% expected, 0.0% during prior month)
- 8:30 a.m. ET: PCE Deflator, month-over-month, December (0.0% expected, 0.1% during prior month)
- 8:30 a.m. ET: PCE Deflator, year-over-year, December (5.0% expected, 5.5% during prior month)
- 8:30 a.m. ET: PCE Core Deflator, month-over-month, December (0.3% expected, 0.2% during prior month)
- 8:30 a.m. ET: PCE Core Deflator, year-over-year, December (4.4% expected, 4.7% during prior month)
- 10:00 a.m. ET: Pending Home Sales NSA, year-over-year, December (-35.4.0% expected, -38.6% during prior month)
- 10:00 a.m. ET: Pending Home Sales, month-over-month, December (-1.0% expected, -4.0% during prior month)
- 10:00 a.m. ET: University of Michigan Consumer Sentiment, January Final (64.6 expected, 64.6 prior)
- 11:00 a.m. ET: Kansas City Fed Services Activity, January (-5 during prior month)
Earnings
- American Express (AXP), Charter Communications (CHTR), Chevron (CVX), Colgate-Palmolive (CL), WisdomTree (WT)
