3 reasons the current stock market rally of 2023 could stall

The surprising stock market rally of 2023 may be due for a punch to the gut.

“While we were looking forward to a market rebound from Q4 of last year, and believe that initially Q1 will stay robust, given what was light positioning and supportive seasonals, we do not expect that there will be a fundamental confirmation for the next leg higher, and see rally fading as we move through this quarter, with Q1 possibly marking the high for the year,” warned influential JP Morgan strategist Mislav Matejka in a note to clients.

Matejka served up three reasons for the caution.

First, the yield curve is staying inverted, and investors shouldn’t ignore the signal’s track record. When the yield curve inverts, it reflects long-term interest rates falling below short-term rates. The move is indicative of investors putting more money to work in longer dated bonds amid fear of near-term economic prospects.

Second, according to Matejka, money supply continues to move lower in the both the U.S. and Europe as interest rates remain on an upward trajectory.

And lastly is that bank lending standards have been tightening, leading to slower demand for credit and usually serving as a precursor to recessions.

“We do not see recession as off the table now, and believe the rally will fade as we move through Q1,” Matejka wrote. “Recession view is being priced out… however, key monetary signals are all sending warnings signs.”

Thus far in 2023, markets have ignored all of these macro warning signals. Investors have also overlooked a borderline dreadful earnings season.

The blended earnings decline for the fourth quarter for the S&P 500 is tracking at 4.7% according to Factset. If this drop holds, it will mark the first year on year profit decline for the S&P 500 since the third quarter of 2020.

Yet, here we are with solid returns in markets year to date.

The Nasdaq Composite has churned out a 12.6% gain year-to-date on the back of pure hype around new artificial intelligence applications from the likes of Microsoft (MSFT), Google (GOOG, GOOGL), and Nvidia (NVDA). Hopes for a Fed pivot on interest rate policy have only lit a further flame to the bid in often high-risk tech stocks.

The S&P 500 has advanced 6.2%, meanwhile, as investors position for a rebound of the Chinese economy following the loosening of COVID lockdowns.

At the same time, various Fed officials have walked back any talk of a pivot on interest rates this month, which has weighed on stocks this month. And earnings from the likes of Walmart and Home Depot this week stand to offer up a mixed view on the U.S. consumer, at best.

All in all, as argued by Matejka, investors may be setting themselves for a springtime disappointment as reasons to be optimistic take a few hits.

“Now fed funds are almost 5%, quantitative tightening is proceeding, the yield curve is negative (has been for three months), and M2 in February is probably down almost -3% year on year (a significant decline),” EvercoreISI chairman Ed Hyman wrote in a research note. “The impact of these monetary conditions will stretch into 2024.”

Source: finance.yahoo.com