Why Is Wall Street Suddenly Celebrating On Monday?

US equities had a surprise reason for celebrating with the first day of the second trading week in the new year. So far, in 2023, Wall Street has swung from sadness to joy.

US Stocks are enjoying a robust year beginning after 2022’s disappointing performance. Even though the Dow fell more than 110 points, or 0.3%, to close Monday’s session, it is still up more than 1% this year. The S&P 500 ended Monday down 0.1% while the Nasdaq gained 0.6%. But both S&P 500 and Nasdaq are up about 1.5% each since the end of December 2022.

Business Fear and Greed Index, which looks at seven indicators of market sentiment, is now inching closer to Greed territory, after suffering for long weeks in the Fear area. But why such optimism exists on Wall Street all of a sudden?

The stock market started to cheer following Friday’s jobs report because it showed slowing wage growth that could lead to additional retreat of inflation pressures and smaller rate hikes from the Fed. But it also showed the pace of job growth is slowing signaling recession.

ISM’s latest data showed the services sector, a big engine of the US economy, contracted in December. A number of prominent companies in the tech, consumer, financial services industries have already announced considerable layoffs or at least announced plans to stop hiring. Retailers such as Macy’s and Lululemon are warning about sales and profits.

In case the Fed is able to carry out a soft landing, slowing the economy without leading to a full-blown recession and significant decline in corporate profits, this will be the most positive outcome Americans can dream of.

Another scenario encompasses falling into a recession, but a decent marginal recession in order to get inflation under control and at the same time bring about no corporate harms. Investors’s hopes are big that this could happen and here lies the obvious reason of the existing optimism.

Any recession will be perceived by investors to be less problematic if inflation is judged to be sufficiently contained, and the Fed is prepared to mount an appropriate monetary response. It is worth mentioning that falling inflation levels should boost stocks this year even as earnings remain dull.

The notion above has surely some critics who have warned that their concern is that most investors ant stock traders are assuming everyone is bearish and, therefore, the price downside in a recession is also likely to be mild. Instead, investors might be surprised by just how much lower stocks go if there is a recession. The market may not be pricing in much weaker earnings.

Investors may also be underestimating how far the Fed is willing to go with rate hikes in order to make sure inflation finally starts to fall. Investors have been reassured by the strength of the US labour market. The Fed is determined to tighten monetary policy until that strength is eliminated.