The markets melt up

The gains of January are extending into February. Leading the gains are those stocks that suffered the worst declines last year. Can this runaway breakout in the averages continue?

The critical trigger that could have broken the markets has come and gone. The Federal Open Market Committee occurred on Wednesday, ending with another quarter-point hike in the Fed funds rate. The bears were convinced that Fed Chairman Jerome Powell would come out swinging with a hawkish monologue. It didn't happen.

In the Q&A session, Powell kept to the line that another rate hike is probable, headway against inflation is encouraging, and the central bank is on track to achieve its monetary goals.

" We can now say, for the first time, that the disinflationary process has started. We can see that," Powell said in answer to a question.

That sentence was worth more than a one percent gain on the S&P 500 Index and more than 2% on the NASDAQ in the last hour of the day. On Wednesday, February 1. For those who are scratching their head wondering why markets should be rallying in the face of a mild recession, continued higher interest rates, declining corporate earnings, and gloomy guidance from many corporate managements, the answer is simple.

Markets discount events six to nine months into the future. If the Fed feels confident in winning its inflation battle, then we are likely heading toward the end of additional interest rate hikes. That means the pressure on the economy and corporate earnings should begin to wane. The bull case is that by late summer, or sometime in the fall, we could see the end of the tightening regime of the Federal Reserve Bank.

Bulls say that at that point the Fed might begin to loosen policy. I don't think that is in the cards, but simply a cessation of tightening would be enough for stocks to rally. Stocks that would benefit the most from such a scenario are growth stocks, with no earnings, but plenty of future potentials. These are the Kathy Wood stocks that were decimated last year. That group of equities has been soaring since the beginning of the year.

It is also the reason that so many companies that have reported disappointing earnings saw their stocks decline at first, but then swiftly recoup losses and forge higher. The reasoning behind those moves is that the present hit to profits and sales will likely disappear and be replaced by better earnings in the quarters ahead, so any dips should be bought.

Is there any guarantee that this bullish scenario will come to pass? Of course not, but for now the most recent data (CPI, PPI, PCE) support a continued decline in inflation. Yields on a variety of bonds from U.S. Treasuries, Corporate, and junk bonds have declined as a result. The only fly in this goldilocks scenario has been the continued strength of the economy and the continued strength in the labor market.

At the end of the week, a spate of disappointing earnings results from three of the largest companies in the world—Apple, Amazon, and Google—seemingly dented the upward momentum in growth stocks. Those results were followed by the non-farm payrolls report on Friday morning that featured a blowout gain of 517,000 jobs. Economists were expecting +188,000 new jobs at best. The unemployment rate dropped to 3.4% versus the 3.6% expected.

Markets declined on the news, but it was not a rout by any means.

Last week, I wrote that my bearish case for the markets in February might not be correct. A bearish decline had become the consensus view, something that always makes me uncomfortable. The evidence seems to indicate stocks want to go higher from here not lower in the short term. Let's see what happens.

Bill Schmick is registered as an investment advisor representative of Onota Partners, Inc., in the Berkshires.  Bill’s forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners, Inc. (OPI).  None of his commentary is or should be considered investment advice.  Direct your inquiries to Bill at 1-413-347-2401 or e-mail him at bill@schmicksretiredinvestor.com .Investments in securities are not insured, protected or guaranteed and may result in loss of income and/or principal.