Will This Bull Market Continue?

There are three primary catalysts responsible for the market trading at its current levels as well as why it has the potential for further gains, stretching right into the second-quarter reporting season in mid-summer.

First, core inflation finally showed some signs of a cooling trend. The change in month-over-month CPI was a genuine relief following two months of hotter-than-forecast inflation numbers.

Second, bond yields are falling despite the Fed holding its Fed Funds rate unchanged at 5.25-5.50 percent. The bond experts are sensing (regardless of the higher-for-longer Fed-speak being touted on the speaking circuit) that there are early signs of consumers’ showing more discretion. This is based on the soft April retail sales data (0.0 percent vs. the predicted estimate of 0.4 percent) and a very low reading from the University of Michigan Consumer Sentiment Survey for May (67.4 versus an estimate of 76.5).

The yield on the 2-year Treasury had fallen from 5.04 percent, at the end of April, to 4.92 percent by the final day of May, while the 10-year Treasury yield slid from 4.74 percent to 4.50 percent over the same period. The direction of the bond market almost always leads the direction of monetary policy.  Even as shelter, food and energy prices remain elevated, the previous Non-Farm Payrolls report for April (175,000 vs. a consensus projection of 250,000) set the current bond rally in motion. This has been a bullish game-changer for stocks.

Thirdly, the market rally is showing improving breadth, as evidenced by the consistently strong advance/decline line, where the most recent trading sessions reveal 3-1 and 4-1 gainers over losers. This is quite possibly the most vital component of the current rally, as it demonstrates that the market is enjoying widespread sector participation and not just the kind of narrow leadership that we observed during the first half of 2023.

For the present, investor confidence has rebounded, with Bank of America’s global fund manager survey showing bullish sentiment among money managers (now at its highest point in more than 2-1/2 years) as 82 percent of investors expect the Federal Reserve to start cutting rates during the second half of 2024, and 78 percent of investors are expecting two, three or even more rate cuts within the next 12 months.

Looking out longer, Wall Street colleagues of mine are beginning to change their outlook to one cut this year, in the fourth quarter, followed by three reductions next year. Their change reflects not only stronger-than-expected year-to-date inflation, but also shifting Fed guidance. A September rate cut is still possible, but only if everything goes right between now and then. A November or December cut is more likely.

The market exuberance came after the first CPI reading of the year had drifted lower. Never mind that the drop was minuscule, and the rate of inflation is still holding well above 3 percent. All that matters is that Fed Chair Jay Powell has signaled the next rate move will, in all likelihood, be down and not up. On that note, major indices moved to fresh all-time highs. 

The Dow Jones Industrial Average traded above 40,000 for the first time ever in mid-May. Nothing gets the bulls excited quite like some big round numbers.  And, in fact, there are reasons to continue to cheer. The U.S. economy has been resilient despite many macro pressures. Corporate earnings season has been better than expected.

The Dow is one of the oldest U.S. indexes and was first launched in 1896. It took almost a century for the gauge to reach 10,000, but subsequent milestones are coming quicker: It hit 20,000 in 2017, and it took less than four years to climb to 30,000 (and that was despite the coronavirus pandemic). Each 10,000 points also just seems easier, with the movement less exciting in percentage terms.

Inflation, however, is still too high, creating a good distance from the “greater confidence” the Fed wants before cutting interest rates. For price pressures to convincingly slow, the data must show many months of lower monthly increases, including particular relief in core services inflation. While the economy is generally in better balance than it was early last year, especially with a cooling labor market, inflation in the pipeline will continue complicating primary Fed goals for months to come.

At this point, it appears that Q1’s inflation will probably not be repeated in the upcoming months. However, there’s a lot more work to do on the inflation front, and the Fed is more likely than not going to cut rates again at some point this year.

Fed commentary did not change after the April CPI. It ranges from “We will cut rates, but not yet,” to “We probably will cut rates eventually, but may need to hike first if inflation does not behave as expected.” From the most hawkish to the most dovish, there is an expectation that inflation will continue to drop, and therefore, the base case forecast is for rate cuts.