There seems to be little to worry investors right now.
The S&P 500 is on track for its best week of the year so far, up more than 2%. That added to gains that have lifted the benchmark more than 10 percent this year, marking a string of record highs.
Other major indexes, such as the Dow Jones industrial average and the tech-heavy Nasdaq Composite, recently traded at or near record highs, as did individual companies as diverse as Microsoft, JPMorgan Chase and Walmart. Shares of social networking company Reddit jumped nearly 50% in their first day of trading on Thursday, a sign that investors are keen to see more tech companies go public this year.
The run was fueled by a wild cash inflow: Investors poured nearly $60 billion into mutual funds that buy stocks in the United States for the week to March 13, a record for data from EPFR Global, which tracks fund flows for more than 20 years. A subsequent outflow for the week through Wednesday—weekly flow numbers can be jumpy—didn’t disrupt the momentum.
This week, the rally continued despite the Federal Reserve forecast on Wednesday that inflation would remain marginally higher this year than forecast a few months ago. As a result, central bank officials expect interest rates to come down more slowly in 2025 than previously forecast and kept their outlook for three basis point cuts this year tight.
Just as the rapid rise in interest rates sent the stock market lower in 2022, the expectation of lower interest rates this year has been part of the case for stocks to rise.
But prospects for cuts are slowly fading, shaken by persistent inflation in the first two months of the year. Investors in the futures market had expected the Fed to cut interest rates as many as six times this year, but recently settled on the central bank’s view that only three cuts are more likely. It doesn’t seem to matter to the stock market’s storming rally.
For some investors, the uptrend is a sign of the Fed’s loosening grip on the fate of financial markets, with money managers confirming that the economy is humming along and can continue to do so even if interest rates remain high.
“It’s a nice transition we’ve had from the Fed needing to cut, to the economy supporting itself, supporting valuations and supporting earnings,” said Alan McKnight, chief investment officer at Regions Bank. “We’re moving from a Fed-led rally to an economy-led and earnings-led rally.”
For some purists, this has always been the case. If inflation had fallen more quickly, it would likely have been a sign of a faster economic slowdown, prompting a series of rate cuts to support it. Although the economy is still cruising, inflation has encountered some resistance on its way to the Fed’s 2% target, but it has also contributed to strong earnings for the country’s public companies. Essentially, purists argue, the Fed has adjusted its stance to good news for markets, rather than investor optimism remaining beholden to Fed policy.
More importantly, investors’ main fear at the start of the year — that inflation could remain faster than the Fed would like, or even accelerate again as the economy falters — has yet to be realized.
“If inflation is a bit strong because the economy is strong, then that’s broadly good for stocks,” said Seema Shah, head of global strategy at Principal Asset Management. “As long as we’re not talking about a resurgence of inflation, that’s pretty good news.”
According to Binky Chadha, an equity analyst at Deutsche Bank, who predicted the rally in stocks last year, while many were still predicting economic turmoil, investors’ expectations of where interest rates will end up are now on par with what futures markets were implying in September. In the intervening period, the S&P 500 soared, a sign of the stock market’s resilience to interest rates staying higher for longer.
For Mr. Chadha, that means the stock market is “disengaging” from the Fed because of the strength of the economy.
US corporate executives are also becoming more optimistic, according to a recent Conference Board survey. Companies are increasing the amount of their own stock they are buying back, a tactic that is seen as helping stocks rise. In another sign of confidence, Meta, Facebook’s parent company, announced in February that it would begin issuing dividends for the first time.
Earnings forecasts for the first quarter of the year, which companies will start reporting in a few weeks, have fallen but remain positive, with majors on track for a third straight quarter of year-on-year profit growth .
Some analysts worry that the rosy outlook underpinning the rally could yet disappoint. Despite growing confidence among executives, the companies are leading analysts to expect more meager earnings growth going forward. (Granted, sometimes this is a play to set expectations low enough to ensure they can outperform.) There are also signs that consumer finances — the fuel that powers the economy — are becoming stretched. And with the presidential election looming, companies could pull back on hiring until uncertainty over the outcome passes.
“It could get worse from here,” warned George Goncalves, chief macro strategist at MUFG Securities.
It’s a setback that even market watchers like Mr. Chadha eventually expect, not while economists and the Fed revise their forecasts to take into account the strength of the economy.
“Right now, the gathering is going on,” he said.
