What’s driving markets: Stocks slip as Powell dents market sentiment

Stock markets have opened lower in the US, as the market digests news that there may only be three rate cuts from the Fed this year. This is that the Fed said back in December when they released their most recent Dot Plot, and Jerome Powell suggested that the forecasts were unlikely to change in the weeks before the March meeting. The market is now having to recalibrate further its expectations for monetary policy, when it should have listened to the Fed all along. Stock markets in the US are falling as bond yields are rising, there could also be some seasonality at play.

February can be a choppy time for markets, and it is the third worst performing month for the S&P 500 going back to the 90s. The S&P 500 reached another record high last week and has registered its 13^th weekly gain in 14 weeks, which is the longest winning streak since 1986! Another way of looking at this good performance, is that US indices could be due a pullback.

However, there are multiple risk factors at play for US indices right now. The Federal Reserve is concerned about inflation risks, and macro data remains strong, particularly the blow out January payrolls report, which has virtually eradicated the prospect of a US rate cut in March. The first-rate cut is now expected in May, however, that will be dependent on the inflation data that is released later this month. We mentioned that the Fed is still in wait-and-see mode, and this means that every bit of labour market and inflation data could trigger market volatility.

US bond yields are rising at the start of the week. The 2-year yield is higher by 7 basis points, and the 10-year yield is higher by 10 basis points. The US yield curve is steepening once again, although it still remains deep in negative territory at -0.33 basis points. This is a normalisation of the yield curve, however, it may not last. There is a growing concern that the soft-landing theory will be put to bed if Powell and co. have to delay rate cuts, or even hike rates again to keep inflation at bay, if that happens then it dramatically increases the chances of a hard landing for the US economy.

This is a big week for earnings reports on both sides of the Atlantic. So far in the US, Estee Lauder shares are up by more than 14% after it reported better than expected earnings reports. Caterpillar also beat earnings estimates and its share price is higher by nearly 5% at the time of writing, and is close to a record high, after it reported stronger earnings growth due to higher prices, even though sales volumes dipped. Sales in North America were strong, which bodes well for the US economy. Caterpillar is seen as a bellwether for the US industrial sector, and it is another sign that the US economy is firing on all cylinders.

Can the US stock market rally for another week?

Us stocks may have got off to a weak start on Monday, but US markets have been extremely resilient in the past few months. To understand whether this rally can last another week, it is useful to understand what factors are driving markets right now. Momentum remains the key factor driving the US stock market, followed by size – with the biggest companies leading the rally, then liquidity, growth and analyst earnings revisions. Momentum has been the biggest driver of the S&P 500 over the last year and when momentum is driving an index, investors need to remember two things. Firstly, it’s hard to go against momentum, and secondly, an event or action can occur out of the blue and knock momentum off course. This means that US indices are in a delicate position, and we shall have to see if the less dovish stance from the Federal Reserve is the event that knocks momentum off course and halts the stock market rally.

The shrinking Magnificent 7

The industries with the highest levels of positive momentum last week were electric utilities, software, semiconductors and technology services. Thus, tech continues to lead the path higher for the US stock market, even if the Magnificent 7 has morphed into the Magnificent 4/5, as Tesla and Alphabet lose steam.

The tech sector continues to dominate the US stock market, even though there have been some notable underperformers in recent weeks and market breadth remains an issue for US stocks. As we move through the week, earnings will be key. There are a number of earnings reports from non-tech companies, and we shall have to see if they can boost their earnings and broaden the rally. Estee Lauder and Caterpillar are a good start.