The disconnect between the recent stock market rally and economic climate helps explain the ongoing volatility. In 2022, the S&P 500 closed out the year down almost 20% while the TSX posted a negative return of 8.5%.
That downward trend was reversed in the opening weeks of 2023 with the S&P 500 advancing 6.2% in January, marking its best opening month in four years. The Nasdaq Composite climbed 10.7% for its best January since 2001. The TSX meanwhile rallied 7.1% in January, making it the best monthly performance in more than two years.
Investor optimism was fuelled on slowing inflation and news that the Bank of Canada would be pausing its interest rate hikes. The U.S. Federal Reserve said inflation was still stubbornly high and additional rate hikes would be needed. But many took that to mean any potential rate hikes would be small.
Why Are Stocks Down?
The rollercoaster ride took a sharp downturn on February 21 with all three major U.S. stock market indexes falling at least two percent, booking their worst daily drop since December. Over a five-day period in mid-February, the TSX slid more than three percent.
Why the reversal? It looks as if investors are finally accepting the fact that the Federal Reserve will need to continue its aggressive rate hikes to tame persistently high inflation. Where traders believed the Federal Reserve would raise its key lending rate by 25 basis points when it meets next in March, there’s a growing consensus it will be a 50-basis point hike.
Economic data certainly points to additional near-term rate hikes. Gross domestic product (GDP) data showed the U.S. economy grew at a 2.7% annualized rate in the fourth quarter. Weekly jobless claims fell to 192,000, below consensus of 195,000.
These two important economic measures show that despite a raft of big rate hikes, parts of the economy remain strong. This increases the odds of a rate hike not just in March, but also in May and June.
Analysts with J.P. Morgan said recently that the stock market could peak for the year in the first quarter, thanks, in part, to the fallout from the Fed’s monetary tightening.
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