The S&P 500 stock index reached a new record high on Friday, signaling hopes for lower interest rates and showing resilience in economic growth. With a closing record high of 4,839.81, surpassing the previous closing high of 4,796.56 set on January 3, 2022, the benchmark index confirmed its status as being in a bull market since October 2022. This positive trend comes after two years of volatility, marked by surging inflation, turbulence in the banking industry, and economic uncertainties.
The stock market experienced significant volatility in early 2022 due to concerns that rising consumer prices would lead to interest rate hikes by the Federal Reserve (Fed). The Fed’s subsequent tightening cycle turned out to be one of its most aggressive in decades, pushing Treasury yields to 16-year highs and causing major upheaval in the stock market. The S&P 500 plummeted by up to 25% from its peak, hitting the lowest point of the cycle in October 2022.
However, the latter months of 2023 witnessed a strong rally as evidence emerged that inflation was cooling down and the Fed adopted a more dovish stance. These factors helped drive stocks higher, resulting in a 24% increase in the S&P 500’s value by the end of 2023. While the market experienced a bumpy start to 2024, surging shares of big technology companies and optimism surrounding artificial intelligence continued to drive gains.
Over the past two years, the relationship between stocks and Treasury yields has been a key driver of market movements. As the Fed raised interest rates in response to inflation, yields soared, eventually reaching a 16-year high in October 2023. Higher yields create investment competition for stocks and raise borrowing costs for companies and consumers. However, expectations of rate cuts in 2024 have recently pushed yields lower, with the benchmark 10-year Treasury yield hovering around 4.2%, compared to the peak of over 5% in October.
Another contributing factor to the stock market’s positive performance is the belief that the Fed’s tighter monetary policy will successfully control inflation without severely impacting economic growth. So far, the U.S. economy has shown resilience, with recent reports indicating strength in retail sales and consumer sentiment. Other economic indicators, such as the producer price index, have suggested a cooling trend. While there are challenges ahead, experts like Seema Shah, Chief Global Strategist of Principal Asset Management, believe that the Fed has a solid chance of bringing inflation back to target without triggering a recession.
Last year, the S&P 500’s impressive gains were largely driven by seven massive stocks with significant weighting in the index: Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta Platforms, and Tesla. These stocks saw substantial surges ranging from 50% to 240% in 2023. Collectively, they accounted for approximately 28% of the S&P 500 and were responsible for nearly two-thirds of the index’s total return. However, owning these stocks has been named the market’s most “crowded” trade for ten consecutive months, according to BofA Global Research’s fund manager survey. Critics argue that the significant rallies in these stocks have made them increasingly expensive compared to the rest of the market.
The elevated valuations of the Magnificent Seven stocks highlight a potential obstacle for the broader market. The S&P 500’s forward price-to-earnings ratio is currently around 20 times, well above its historical average of 15.6 times. This higher starting valuation presents a challenge for positive earnings surprises and market returns, as noted by Brent Schutte, Chief Investment Officer at Northwestern Mutual Wealth Management Company.
The S&P 500’s record high reflects optimism for lower interest rates and demonstrates the market’s resilience amidst periods of volatility. Factors such as the interplay between stocks and Treasury yields, a resilient economy, and the performance of specific stocks have influenced the market’s trajectory. However, concerns about elevated valuations warrant caution as investors navigate through potential challenges and opportunities in the coming months.
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