The stock market has recorded its best gain of the year, as investors take comfort in early signs that inflation is easing and the economy is holding up.
The S&P 500 rose 1.7 percent on Friday, taking the gain for the week to 3.3 percent and marking its fourth consecutive positive week, a feat it had not achieved since October. The index is now more than 16 percent higher than the low point in June, although it is still 10 percent lower for the year.
The rally is in stark contrast to the first half of the year, when Wall Street got off to its worst start in half a century, when the war in Ukraine, soaring energy costs, rising interest rates and rapid inflation fueled investors̵[ads1]7; fears about the health of the economy.
Federal Reserve officials have suggested that their campaign for rate hikes to tame inflation is far from over. But some investors see recent economic data as grounds for the central bank to move less aggressively, easing concerns that higher borrowing costs could push the economy into a severe downturn.
Frequently asked questions about inflation
“The peak of freaking out about inflation and interest rates is over and we’re looking at something that’s not quite as dramatic,” said Michael Purves, founder and CEO of Tallbacken Capital.
The latest consumer price index report, released Wednesday, gave Wall Street a moment of relief as inflation eased to 8.5 percent over the year through July, down from 9.1 percent the previous month. The data provided an early indication that the Fed’s efforts to curb inflation may be having an effect.
Also, data showing that in July the economy regained all the jobs lost in the pandemic, along with weeks of better-than-expected earnings reports from companies, has dampened some concern among investors that higher prices, which increase costs for companies, could cut deeper into corporate America.
The CBOE Vix volatility index, also known as Wall Street’s “fear gauge” because it reflects a sense of investor uncertainty about stock market movements, dipped below its long-term average of 20 points this week. The Vix had been holding above this mark since April, so the lower reading could be a sign that investor consternation over another downturn has subsided.
“We’ve seen a number of inflationary pressures start to roll over,” said Patrick Palfrey, senior U.S. equity strategist at Credit Suisse. He added that this “forces” investors to reassess their trading positions.
Bankers said retail investors had helped drive the rally. Strong increases in so-called meme shares and an increase in certain cryptocurrencies also point to large participation from individual investors.
“The cornerstone of this is the labor market, and it’s rock solid,” said James Masserio, a co-head of equities for the Americas at Société Générale. “If you don’t have a job, you don’t buy meme stocks.”
Experts also said stock markets were poised to move higher. Investors had scaled back their bets on the market due to uncertainty. Trading volume has also been low, with many large investors taking holidays throughout August. As a result, even small amounts of buying interest have helped lift the market, with momentum building as other investors chased returns.
Understand inflation and how it affects you
More than $11 billion flowed into funds buying U.S. stocks in the week to Wednesday, according to EPFR Global, the most in eight weeks.
But some bankers warned that as quickly as markets have recovered, they could fall again. Short-term gains are not uncommon during periods of prolonged losses, known as bear market rallies.
After peaking in October 2007, the S&P 500 fell more than 50 percent by November 2008 in the wake of Lehman Brothers’ collapse. The index then rose by almost 24 per cent within a few weeks. But the sale wasn’t over. The S&P 500 gave up all of those gains in early 2009, before bottoming out in March of that year.
Mr. Masserio said the Fed’s task of bringing inflation back to its 2 percent target was like turning an oil tanker: slow and fraught with risk.
“Fundamentally, what has built up in the system is much more difficult than what we can fix in six months with a shift in monetary policy,” he said, warning that the stock market’s problems may not be over yet.
Stocks are higher because the inflation outlook has improved and the economic backdrop remains supportive. Although expectations are not as gloomy as they were, there are doubts about how long the rally can last.
“I’m bullish on the market, but I’m still an anxious and nervous bull,” Mr. Purves said. – We are not out of the woods yet.