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Global dynamics, rate expectations, and earnings impact market volatility;
Bull market persists, pullback brings investment opportunities
Last week, the three major US stock indexes closed with mixed movements. From a weekly perspective, the Dow Jones Industrial Average (DJIA) edged up by 3.16 points, or 0.01%, to close at 37,986.40 points; the S&P 500 index fell by 156.18 points, or 3.0%, to close at 4,967.23 points; and the Nasdaq Composite (NASDAQ) dropped by 893.08 points, or 5.5%, to close at 15,282.01 points.
Key Takeaways:
Global dynamics, rate expectations, and earnings impact market volatility;
Bull market persists, pullback brings investment opportunities
After a strong rally in the stock market, markets have started to soften in recent weeks. We know that market corrections are normal in any given year, especially after the S&P 500 index rose by 25% over the past six months. The S&P 500 has closed lower for the third consecutive week, while the tech-heavy Nasdaq has been down for the fourth consecutive week. So far, the magnitude of the market pullback has been relatively small: the S&P 500 index has fallen by about 5.5% from recent highs, while the Nasdaq index has fallen by about 7%. However, parts of the market that are sensitive to interest rates, including small-cap stocks and the real estate industry, have experienced larger declines. Additionally, the VIX volatility index, sometimes referred to as the "fear index," has approached highs for the year.
The recent volatility in the market has been sparked by a triple impact of recent data and news:
- First, the market has reassessed expectations for Fed rate cuts, now expecting only one rate cut in 2024, or even none at all. The market is adjusting to this new "higher for longer" interest rate environment.
- Second, geopolitical tensions are rising, especially in the Middle East, which has put upward pressure on oil and commodity prices in recent weeks.
- Third, the first-quarter earnings season for the S&P 500 is underway. Although companies have exceeded expectations in terms of earnings, their outlooks have been weaker than expected. Major tech companies, including Microsoft, Google, and Meta, will report earnings this week, and investors will closely watch for any signs of weakness.
Consumers continue shopping, but housing market shows signs of stress:
- Some strong economic data appeared to increase worries that the Federal Reserve would push back any interest rates cuts to the fall, if not to 2025. On Monday, the Commerce Department reported that retail sales rose 0.7% in March, well above consensus expectations of around 0.3%, while February’s gain was revised upward to 0.9%. Rising gas prices were partly at work (the data are not adjusted for inflation), but the strength was broad-based and included healthy gains in discretionary categories, such as restaurants and bars and online retailers.
- Conversely, downward surprises in housing market data may have furthered inflation fears by auguring continued supply tightness. Housing starts and permits in March came in well below expectations and declined from February, with the former falling to the lowest level in seven months. Existing home sales also declined, although largely in line with expectations, as the average 30-year mortgage rate climbed above 7% for the first time since December.
Market volatility after a strong rally is not unexpected. Although it's difficult to predict the bottom of a pullback, we know that corrections in the range of 5% to 15% occur every year. Some investors are concerned that the market pullback could evolve into a deep or prolonged bear market environment (typically with losses of 20% or higher). We see this as unlikely, especially considering that the U.S. economy remains fairly strong, supported by robust consumer demand and a healthy labor market, and global economic growth is also stabilizing. Therefore, investors can use this pullback to rebalance, diversify, and use dollar-cost averaging, especially those who have not fully participated in the recent rapid rise.
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Opening Market Update:
Wall Street enters the heart of earnings season reeling from fierce selling that sent the broader market to two-month lows late last week, chopping the 2024 rally in half. Tech and other growth sectors suffered most amid rising Treasury yields, geopolitical fireworks, and mixed earnings news, but there are signs of oversold conditions.
For bullish investors, it's likely a letdown to see the S&P 500® index (SPX) dip back below 5,000 or witness the Dow Jones Industrial Average® ($DJI) approach 40,000 and then retreat so dramatically. Both the SPX and the Nasdaq-100® (NDX) are on six-session losing streaks, and last week was the worst in more than a year for the SPX as formerly high-flying semiconductor shares fell back to Earth.
Keep in mind, though, that it's normal for the market to spend weeks or even months consolidating gains. The 5% drop from all-time highs could represent a healthy pause for Wall Street, which hadn't experienced a major pullback since last October. The 25% rally from then to late March took major indexes to historically high valuation levels above 20 on a price-to-earnings (P/E) basis for the SPX, which history suggests are tough to maintain as interest rates stay higher for longer.
Strong earnings, if they arrive, could help from a valuation standpoint. Earnings take center stage starting with Tesla (TSLA) tomorrow, followed by Microsoft (MSFT), Meta Platforms (META), and Alphabet (GOOGL) later this week. Overall, about one-third of S&P 500 companies report this week.
Another helpful factor might be any sign of inflation progress, and the March Personal Consumption Expenditures (PCE) prices report, the Federal Reserve's favored inflation metric, is due Friday.
The US stock market is in a bull market. Ai Financial, with its professional investment philosophy, seizing the opportunities of our time together and reap wealth.
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