Briefly on Friday, the S&P 500SPX, +0,88%traded above 4,200 for the first time since August, according to FactSet data.
The short-lived triumph sparked a race among stock gurus, who released reams of research to explain what they believed had led to a rally that few on Wall Street expected just a few months ago.
Are investors chasing returns? Expectations for a soft landing? Is the Federal Reserve quietly pumping liquidity into the market as it continues to raise interest rates? The market's insatiable hope that the Fed will soon change course and start cutting interest rates? Or is it just a factor in the AI frenzy breathing new life into tech stocks?
Of course, the 4,200 level is stubbornly firm resistance from last summer. The S&P 500's failure to sustain a rally above that could set the stage for another big pullback, analysts warn.
At the same time, however, the market's resilience in the debt-ceiling battle that could trigger a tumultuous bankruptcy has confounded the bears.
Stock market bulls pointed to historical data suggesting the market's recovery may have more room — despite the potential debt ceiling disaster that Treasury Secretary Janet Yellen and many others have warned about.
The chase after the rally
A relatively simple explanation for why stocks have rallied this year is that pessimistic asset managers have essentially chased the market under pressure to increase yields while their benchmark, the S&P 500, has soared higher.
Here's how Tom Essaye, founder of Sevens Report Research, explained it: When 2023 began, most Wall Street traders expected stocks' rally from the October lows to turn out to be another short-term bearish rally.
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Unfortunately for them, the market tends to punish proponents of "consensual" trades like this, Essaye said in an emailed comment. The result: The S&P 500 is up 20% from its intraday low since Oct. 13, according to FactSet data.
"Throughout 2023, due to a long and significant list of risks facing the markets, investors (particularly institutional investors) expected stocks to decline (this was supported by numerous sentiment and investment surveys throughout the year)," Essaye said.
“But as those risks failed to materialize, it caused an increase in 'pain trading' as disinvested managers chase higher yields, which is exactly why the S&P 500 hit its highest level since August last week.
Essaye cited a Bank of America global survey of fund managers as evidence that Wall Street experts have been too pessimistic in recent months.
Research shows that professional money managers have stuck to their cautious outlook while staying lean.
Central bank liquidity
For more than a decade after the 2008 financial crisis, U.S. stocks have rallied reliably, buoyed by central banks pumping money into the global economy and markets while cutting interest rates and raising bond yields.
But as stocks bottomed out, the tides of global central bank liquidity began to return, first abroad and then in the US.
Citigroup's Matt King blamed a handful of foreign central banks for unleashing the flood of liquidity that began late last year, led by the People's Bank of China.
I see: The secret to the success of shares so far in 2023? An unexpected $1 trillion surge in liquidity from central banks.
More recently, others have pointed to the jump in reserve balances at Federal Reserve banks as a sign that the Fed has quietly propped up markets and the banking system after the collapse of Silicon Valley Bank.
Reserves rose by about $440 billion shortly after the Federal Deposit Insurance Corp. bought by SVB. And they remain nearly $300 billion higher than levels since the first half of March, according to the latest data released by the central bank.
"The strong performance in the stock market from the March lows has far more to do with liquidity injections to avoid panic during today's regional banking crisis than the economic outlook, the Fed outlook or even artificial intelligence. Matt Maley, Chief Market Strategist at Miller + Tabak Co., said in an emailed comment shared over the weekend.
Fears of an impending recession have dissipated
The strategy team at JPMorgan Chase & Co.JPM, +0,24%has repeatedly told clients that a stronger-than-expected labor market and the U.S. economy are the most important factors behind the stock's rise.
Many investors expected a recession to begin as early as the first quarter of 2023. That didn't help support stocks.
"The general perception is that investor bearishness is pervasive, but at the same time a potential recession is not seen as imminent, with a strong labor market cited as one of the key current supports," one group said. of global equity strategists led by Mislav Matejka, the bank's London-based equity analyst, in a note shared with JPMorgan and MarketWatch clients.
About 253,000 new US jobs were added in April, beating economists' expectations, while wages rose sharply, suggesting there remains strong demand for labor even amid some signs the economy is slowing.
Corporate earnings also beat the expectations of pessimists on Wall Street in the first quarter, although profits of the largest US companies fell for the second quarter in a row.
With the first-quarter reporting period nearly over, S&P 500 companies are on track to report a compounded year-over-year decline of about 2.2 percent, according to FactSet data. That compares with expectations for a 6.7% decline.
The madness of artificial intelligence
The market was unusually concentrated in 2023, with the largest megacap tech stocks driving most of the market's gains, offsetting weaknesses in energy stocks, small caps and other parts of the market.
Many of the stocks that have been the biggest drivers of the S&P 500's year-to-date gains are associated with companies at the forefront of what some analysts have described as an artificial intelligence revolution. That includes stocks like Microsoft Corp.MSFT, +3,85%,Google parent company Alphabet Inc.GOOG, +2,23%i chip div Nvidia Corp.NVDA, +24,37%— the latter of which has doubled since the beginning of the year.
Partly as a result, the 10 largest S&P 500 stocks have seen a 32% increase in value since the start of the year, while the rest of the index has remained essentially flat, according to analysts at 3Fourteen Research.
That outperformance prompted some caution on Wall Street, with Bank of America chief investment strategist Michael Hartnett telling the bank's clients that AI stocks are now in a "baby bubble."
Where from here?
The S&P 500 ended Monday without a new high since August, but the Nasdaq CompositeCOMP, +1,71%succeeded where the S&P 500 failed, ending the day at 12,720.78, according to FactSet data.
If the historical pattern holds, stocks could rise, although consumer confidence remains subdued amid fears that a recession could hit later this year.
Ryan Detrick, chief market strategist at the Carson Group, found that stocks almost always finish the year higher after rising 8% or more in the first 100 sessions of the year, a milestone reached on Thursday.
Stocks end the calendar year up 86% of the time when they're up 8% or more at this point in the year, Detrick found, with an average return of 10%.