Why the Stock Market’s Rally Needs New Fuel

The reversal of sentiment that led the surge may have left some investors skeptical, yet they have waited in vain for a major correction in assets at the more speculative end of the spectrum. That is partly because strong economic data has bolstered confidence in the outlook.

Yet Big Tech and other market leaders have already gotten plenty of traction out of 2023’s optimism. And the ripple effects of the rapid rise in interest rates over the past year or so may not have fully been felt. Real interest rates, which account for the impact of inflation, have only recently turned positive, meaning borrowing costs will now seem even more onerous.

That leaves the question of what could drive the next leg of the rally, Capital Economics senior markets economist Thomas Mathews wrote in a research note on Friday. Other market watchers are asking the same question.

Mathews said that the market’s gains don’t look excessive given the resilience of the economy, even if second-quarter corporate profits and outlooks haven’t quite lived up to expectations in some cases. Shares of both
Apple
(ticker: AAPL) and
Microsoft
(MSFT) fell after their reports.

But with the earnings season shaping up to be an uneven one, it leaves one less factor that could keep pushing stocks higher. Last month, plenty of market strategists  were noting how important Big Tech earnings would be to keeping the rally going.

“The markets may be listless for the next month in the absence of market-catalyzing news and after a strong run,” wrote Jason Draho, head of asset allocation for the Americas at UBS Global Wealth Management. “It will likely take the release of August data and the September Federal Open Market Committee meeting for the market narrative to shift notably, in one direction or another.”

Certainly on a historical basis, August hasn’t been known for its big returns, leading Fundstrat’s Tom Lee to note that markets could struggle for traction this month.

The upshot, argues Matthews, is that while there isn’t much at present to derail the rally, there also isn’t an obvious reason for it to keep delivering outsize returns.

“We’re growing less confident in our view that a recession in the U.S. will cause risk assets to struggle over the back half of the year…But if there are to be further big gains, we suspect they’ll have to come from something other than continued economic resilience,” he wrote. “One candidate for this is enthusiasm about new technology, such as AI or superconductors, which could, plausibly boost equity valuations.”

He’s not the only one who argues that the market needs hope about AI or similar innovations to keep soaring.  

“Bottom line, at current levels, the S&P 500 has priced in: 1) No hard landing, 2) Falling inflation, and 3) A Fed that won’t be raising rates much longer (and possibly cutting soon after),”  Sevens Reports’ founder Tom Essaye wrote last month.

“That’s basically the best outcome anyone could have hoped for at the start of the year, and that means the gains in stocks are legitimate, but also likely exhausted in the near term and it will take something else to push stocks materially higher from here.”

Write to Teresa Rivas at [email protected]