Weekly Market Brief: February 5, 2024

What a week!

The Fed kept interest rates on hold. That decision itself was no surprise, but Jerome Powell poured cold water on the odds of a March interest rate cut, and that triggered a risk reset: The S&P 500’s 1.6% decline on Wednesday was the biggest 1-day drop for stocks since September. Oddly, Powell wasn’t asked about risks in the banking sector after New York Community Bank reported weak earnings results and cut their dividend in response to growing distress in commercial real estate. The larger focus for Powell was balancing the risks of reaccelerating press conference against the resilience of the US labor market.

It seems the labor market is doing just fine, though. On Friday, the BLS announced that the US added 353,000 jobs in January, the strongest nonfarm payrolls report in a year. That blowout number - along with the lower than expected Q4 unit labor costs reported on Thursday - helped the stock market more than reverse Wednesday’s selloff. The S&P 500 closed at another new all-time high and as risen for 13 of the last 14 weeks.

How long can the rally last? Not forever, of course. And the recent strength out of the US Dollar doesn't seem consistent with the rise in stock prices.

Remember the bear market of 2022? The only thing that mattered that year was interest rates and the US Dollar. Every time rates moved higher and the Dollar surged, stock prices fell to a new low.

Last year really wasn’t that much different. The US Dollar was subdued and rangebound, and that was good for stocks. Still, big swings in the DXY were mirrored by moves in the S&P 500.

The last month has been different. The Dollar has been strengthening all year, but stocks have ignored the move:

So which one breaks first? Stocks? The Dollar? Or the correlation?

Earnings Expectations and Valuation

The 2022 bear market decline was not driven by a deterioration in corporate earnings. Though stock prices dropped well over 20% from their peak to trough, expected future earnings remained stubbornly high. That divergence pushed the S&P 500 forward price-to-earnings ratio from more than 22x (a level previously seen only during the late-1990s) to 15x (a level in-line with historical averages).

The bull market that reigned in 2023 and has continued into 2024 has been the opposite experience. Stock prices have risen 40% from their lows, but S&P 500 earnings haven’t kept up at all, taking valuations back above 20x forward earnings estimates. Fortunately, profits are expected to grow double digits in each of the next two years, and that would help make the current multiple easier to digest.

What’s Ahead

Here’s the economic calendar for the week ahead