Behind the stock sell-off and whether the bull market is at risk
It’s really not as simple as saying good news on the economy was treated as bad news on Wall Street. Yes, the S & P 500 shed 1.5% Friday, after December payroll growth of 256,000 was 100,000 above forecasts and the unemployment rate fell a tick to 4.1%. But the mini-market tantrum is less about disliking prosperity than worrying it might not be sustainable given the way bond yields and the Federal Reserve are acting in response. What the market knows is that the economic data released early in each year since the pandemic has come in hot, only to moderate and sometimes give way to a “growth scare” months later. What the market fears is that the bond market and Federal Reserve will extrapolate the strong jobs numbers and tighten financial conditions more than important parts of the economy (housing and manufacturing) can tolerate. What the market is unsure about is how the impending policy mix of tariffs, immigration restrictions and deregulation will alter this interplay of rates, inflation, GDP growth and risk appetites. It has taken the markets to a slightly vexing crossroads, where typical mid-cycle apprehension about an expansion’s durability intersects with aggressive market pricing of future growth and an unsettled policy setup. With it all, though, stocks simply tested the floor of their post-election range, the S & P 500 now having spent the majority of the past 15 trading sessions within the range it traveled on Nov. 6, the day after Donald Trump’s win. .SPX 3M mountain S & P 500, 3 months The 10-year Treasury yields has run right up to its April high, in the upper zone of many fair-value estimates for bonds, with the yield appearing stretched on a technical basis. Given the magnitude of the employment beat, the 10-year’s Friday jump from 4.68% to 4.76% was hardly evidence of utter shock and price dislocation, but simply an extra push in the direction the market has been moving for months. In a way, the ramp in yields and the dollar was essentially validated as largely fundamentally driven by the strong payrolls print, which nonetheless caused the market to price out the chances of a near-term rate cut. Macro factors worrying market There’s nothing inherently unwelcome about a Fed that goes on hold. I’ll keep pointing out until reality makes the observation moot that in the vaunted mid-’90s soft landing, stock-market surge and productivity boom, the Fed followed an aggressive rate-cutting campaign with a mere three rate cuts in 1995 and early 1996 before pausing to hold them steady for a year. And even a 4.75% Treasury yield doesn’t appear to represent a punishing level for stocks or badly mispriced given current nominal GDP growth rates, even if fatter inflation-adjusted yields should be attracting fundamental asset-allocation buyers here. Credit markets have remained firm, sending a reassuring macro message, yet the upward march in Treasury rates has meant high-grade corporate debt offers a pretty safe yield approaching 6%. Henry McVey, KKR’s head of global macro, reacted to the Friday employment report like this: “We think the U.S. dollar is in a class of its own. Our Regime Change thesis of faster nominal growth and a higher resting heart rate for inflation continues to gain momentum. This shift suggests that credit as an asset class has gone from a nice to have to highly compelling on a risk-adjusted basis, particularly over 3-5 year duration.” But again, with yields high enough to make them alluring to more buyers, can homebuilding lift itself off the mat given that it means 30-year mortgage rates above 7%? Or is the housing cycle no longer synonymous with the economic cycle? And will the ascendant dollar feasting on universal faith in U.S. economic exceptionalism at some point create ruptures in global asset markets? The issue is whether the briskly growing services sector and headlong AI-investment buildout can bolster aggregate growth rates in a way that doesn’t bring additional stress on the housing and goods-producing sectors. The reality is, these macro factors in flux are interacting with a market reaching toward longer-term extremes in valuation, which had just posted among the best two-year gains in history, after which investors universally aligned themselves behind a bullish 2025 outlook — at just the moment that a hard-to-handicap policy path began to sap near-term conviction. Bull trend intact? A variety of measures suggest a less-generous, if still upward-tilted, market scenario should have been assigned a high probability entering 2025. Jim Paulsen of Paulsen Perspectives plots the current advance, which started in October 2022, against the average bull-market path since 1945. The proper inference is both to keep expectations anchored while also taking some comfort in the fact that if the market undergoes a frustrating, churning range for a while longer, it doesn’t necessarily mean the overall bull trend is spent. Bank of America technical strategist Stephen Suttmeier sets out a similar view, saying, “The theme for 2025 is that the S & P 500 can be a victim of its own success. After two strong years in 2023 and 2024, risk increases for an uninspiring 2025. The SPX has rallied a third year in a row 67% of the time but with lackluster average and median returns.” One optimistic talking point making the rounds is that, on a three-year basis, the S & P 500’s performance has been middling, and therefore the tape is not particularly extended. This is mostly because the three-year lookback lands at the exact peak of the market preceding the 2022 bear market, a particularly unflattering start point. As illustrated in this chart, though, if the S & P 500 were merely to remain flat for the next nine months until the three-year anniversary of the October 2022 low, the trailing three-year gain would be in the upper level of the historical range. Next week brings the CPI inflation report and the early edge of corporate-earnings season. Given the hawkish recent data and aggressive bond-market action of late, it’s fair to suggest there’s room for a dovish takeaway from a reasonably as-expected CPI. As for earnings, they are expected to rise some 11.7% for the fourth quarter, the fastest pace in three years, according to FactSet. Given the broader macro backdrop and the typical pattern of companies beating estimates, this should be more supportive than not. Still, Ned Davis Research strategist Ed Clissold says, “the earnings environment is likely to be the toughest in three years,” largely due to much more aggressive growth forecasts leaving less room for pleasant surprise, as well as decelerating mega-cap-tech growth rates and rising interest expense. See a pattern here? Things are pretty good but are already expected to be good and to remain so for a while. This all helps explain why markets have been harder to please and easier to rattle in recent weeks. It’s too soon to say this phase of indecisive churn is the start of anything much nastier – especially because that very churn has pulled the median stock down by almost 8% since Thanksgiving, which is the market’s way of draining elevated expectations from the price.
