NEW YORK, Feb 10 (Reuters) – US stocks, which took a hit last year, are rallying for the first few weeks of 2023, leading markets higher. Some investors consider this trend unlikely.
Stunning gains in shares of companies like Nvidia (NVDA.O), Netflix (NFLX.O) and Meta Platforms (META.O) lift sectors that struggled with last year’s sell-off, including technology (.SPLRCT) and Communication Services (.SPLRCL).
Smaller stocks that tumbled in 2022 have also burst out of the gate: A basket of underperforming tech stocks from Goldman Sachs, which tumbled over 60% in 2022, has rallied 21% in 2023, representing the S&P 500’s 6.5% gain in the shadows.
A number of factors are driving the moves, including the appeal of struggling stocks, tailwinds from falling bond yields and market participants unwinding bearish bets on stocks.
However, some investors are skeptical that the gains will last, especially as markets continue to recalibrate expectations of how much the US Federal Reserve will need to raise interest rates this year to further cool inflation.
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While it’s not uncommon to see a turnaround early in the year, “the extent to which it has occurred is quite dramatic,” said Walter Todd, chief investment officer at Greenwood Capital. “It certainly cannot go on as extreme as it has been.”
Greenwood Capital recently sold at least a portion of its stake in some 2023 winners, including Meta Platforms and Netflix. Meta is up 45% so far this year, while Netflix is up nearly 18%. These stocks have fallen 64% and 51%, respectively, over the past year.
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The S&P 500 rose 6.2% in January as many investors quickly increased their stock positioning after reducing it last year, emboldened by several months of eased inflation readings. One metric, stock positioning for systematic investors, has risen to its highest level in a year, according to a Deutsche Bank report released on Feb. 3.
Moderating bond yields, which rose sharply in 2022 as the Fed hiked rates to combat rising inflation, bolstered the case for picking up last year’s losers. The yield on the benchmark 10-year US Treasury bond fell about 40 basis points in the first few weeks of the year to 3.4% in early February after hitting 15-year highs last year.
While falling yields make stocks more attractive in general, they’re particularly beneficial for technology and growth stocks, whose valuations suffered as yields soared in 2022.
“When rates go down, lower quality, longer duration assets are good,” said Rob Almeida, global investment strategist at MFS Investment Management.
However, yields have risen again in recent days as investors upgraded estimates of how much the Fed will hike rates and how long the central bank will keep them at peak levels. That weighed on stocks last week, as the S&P 500 fell 1.1% after two straight weeks of gains.
“Previous leaders … are vulnerable to longer-term higher interest rates and a slowing economy,” strategists at the Wells Fargo Investment Institute said in a statement Thursday. “We don’t see the recent breadth and leadership as sustainable – not yet – and prefer not to chase equity rallies at this time.”
Investors will be watching Tuesday’s US consumer price data release closely for signs that inflation is weakening further.
David Kotok, chief investment officer at Cumberland Advisors, is skeptical about the recent rally and some of the stocks leading the current run. His company is underweight many of the big tech and growth stocks that rallied in 2023, favors healthcare and defense stocks, and has a large allocation to cash.
“Either last year’s deterioration from an overvalued area is over, or this is a dead hop in a wounded large sector and last year’s bear market isn’t over yet,” Kotok said. “I’m in the latter camp.”
Certainly, there are some signs that the leadership could continue to do well.
Since 1990, the three best-performing sectors in January have averaged returns of 11.3% over the next 12 months, according to investment research firm CFRA Research, versus the S&P 500’s average gain of 9.3% over that period.
Matt Stucky, senior portfolio manager at Northwestern Mutual Wealth Management Company, said some of last year’s hardest-hit stocks could continue to rise in the short-term as investors take more short positions.
Short sellers have covered $51 billion of their bearish bets so far in 2023, or about 6% of all stocks that have been shorted, including over $1 billion in short sales, respectively, of Amazon (AMZN.O) and Alphabet ( GOOGL.O) relate to the financial and analytical company S3 Partners.
“Can this last a quarter or two? Yes,” Stucky said. “Can it last all of 2023 or a period of several years? Probably not.”
reporting by Lewis Krauskopf; Edited by Ira Iosebashvili and Deepa Babignton
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