NEW YORK (`) — Wall Street returned to record highs on Friday, capping a tough two-year stretch marked by high inflation and worries about a recession that seemed inevitable but has not yet materialized.
The S&P 500, the centerpiece of many 401(k) accounts and the main gauge professional investors use to gauge the health of Wall Street, rose 1.2% to 4,839.81. It recouped recent losses since its previous record of 4,796.56 at the start of 2022. During that time it fell by as much as 25% as inflation rose to levels not seen since Thelonious Monk and Ingrid Bergman in 1981.
More than high inflation itself, Wall Street's fear took center stage the medicine that the Federal Reserve traditionally uses to treat it. These are high interest rates that slow down the economy by making borrowing more expensive and depressing the prices of stocks and other investments. And the Fed quickly raised its key interest rate from virtually zero to its highest level since 2001, in a range between 5.25% and 5.50%.
In the past, the Fed has helped cause recessions by raising interest rates like this. At the beginning of last year, there was a general expectation on Wall Street that it would happen again.
But this time it was different, or at least it has been so far. The economy is still growing, the unemployment rate remains remarkably low, and optimism among U.S. households is increasing.
“I don’t think this cycle is normal at all,” said Niladri “Neel” Mukherjee, chief investment officer of TIAA’s wealth management team. “It’s unique, and the pandemic has introduced that element of uniqueness.”
After spiking as snarled supply chains caused shortages due to COVID-19 shutdowns, inflation has cooled since its peak two summers ago. Easing has progressed to the point where Wall Street's biggest question now is when the Federal Reserve will start cutting interest rates.
Such interest rate cuts can act like steroids on financial markets while reducing the pressure that has built up on the economy and the financial system.
Treasury yields have already fallen significantly on expectations of interest rate cuts, which helped the stock market's recovery accelerate significantly in November. The yield on the 10-year Treasury note fell to 4.13% on Friday, well below the 5% it reached in October, its highest level since 2007.
Of course, some critics say Wall Street has once again outdone itself when it comes to predicting when the Federal Reserve might start cutting interest rates.
“The market is addicted to rate cuts,” said Rich Weiss, chief investment officer of multi-asset strategies at American Century Investments. “They just can’t get enough of it and are myopically focused on it.”
Since the Fed's rate-hiking campaign began in early 2022, traders repeatedly predicted an impending rate cut, but were disappointed as high inflation proved more stubborn than expected. If this happens again, the big moves up in stocks and down in bond yields may need to be reversed.
This time, however, the Fed itself has indicated that rate cuts are imminent, although some officials have suggested they could begin later than the market hopes. According to data from CME Group, traders are betting that the likelihood that the Fed will begin cutting interest rates in March is almost like a coin toss.
“The truth is probably somewhere between what the Fed says and what the market expects,” said Brian Jacobsen, chief economist at Annex Wealth Management. “This will continue to lead to dips and disruptions” in the financial markets “until the two are reconciled.”
Some encouraging data came Friday after a preliminary report from the University of Michigan suggested that sentiment among U.S. consumers is surging. The mood has risen to its highest level since July 2021. This is important because consumer spending is the main driver of the economy.
Perhaps even more important for the Fed: Household expectations of upcoming inflation also appear to be anchored. A major concern is that such expectations could get out of hand and create a vicious cycle that keeps inflation high.
Wall Street's rise on Friday was accompanied by a strong rebound from technology stocks, typical of the uptrend.
Several chip companies rose for a second straight day after heavyweight chipmaker Taiwan Semiconductor Manufacturing Co. gave better sales forecast for this year than analysts expected. Broadcom rose 5.9% and Texas Instruments rose 4%.
Overall, the S&P 500 rose by 58.87 points to its record level. The Dow Jones Industrial Average set its own record a month earlier, rising 395.19, or 1.1%, to 37,863.80 on Friday. The Nasdaq Composite rose 255.32, or 1.7%, to 15,310.97.
Last year, a select few Big Tech companies accounted for the bulk of the S&P 500's gains. Seven of these accounted for 62% of the index's total return, according to S&P Dow Jones Indices.
Many of these stocks – Microsoft, Apple, Alphabet, Nvidia, Amazon, Meta Platforms and Tesla – made waves in the market around artificial intelligence technologies. The hope is that AI will lead to a boom in profits, both for companies that use it and those that provide the hardware to do it.
Investors might have wished they had just stuck with these stocks, nicknamed “the Magnificent 7.” But some of them remain below their record values, such as Tesla. It is still 48% below its November 2021 all-time high.
The S&P 500's return to a record on Friday is another example of how investors who remain patient and spread their investments across the U.S. stock market end up recouping all their losses. Sometimes it can take a long time, such as the lost decade from 2000 to 2009, when the S&P 500 crashed due to the bursting of the dot-com bubble and the global financial crisis. But the market has a history of restoring investors to health given enough time.
Including dividends, investors with S&P 500 index funds broke even a month ago.
Of course, risks remain for investors. In addition to the uncertainty over when the Fed will begin cutting interest rates, it is also still not certain whether the economy will avoid a recession.
Rate increases notoriously take a long time to fully penetrate the system and can cause problems in unexpected places in the financial system.
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` writers Matt Ott and Zimo Zhong contributed.
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