Sentiment on stocks is positive despite the bad headlines

New York

It’s only early January, but so far in 2023, Wall Street has swung (to paraphrase Billy Joel) from sadness to euphoria.

Shares got off to a solid start after last year’s poor results. Although the Dow was down more than 110 points, or 0.3%, by Monday’s close, it is still up more than 1% this year. The S&P 500 ended Monday down 0.1 percent, while the Nasdaq gained 0.6 percent. But each of those two indexes has risen by about 1.5% since the end of 2022.

Even CNN’s Business Fear and Greed Index, which looks at seven indicators of market sentiment, is now inching closer to Greed territory — after languishing in Fear mode for much of the past few weeks.

But why is there so much optimism on Wall Street all of a sudden? The titles still aren’t necessarily that great.

Yes, the market welcomed Friday’s jobs report as it showed a slowdown in wage growth that could lead to further easing of inflationary pressures and smaller rate hikes by the Federal Reserve. But it also showed that the pace of job growth is slowing — and that could be a precursor to an eventual recession.

Meanwhile, the latest data from the Institute for Supply Management showed that the services sector, a big engine of the US economy, contracted last month. And several high-profile companies in the tech, consumer, financial services (and yes, media) industries have announced big layoffs or revealed plans to hand out pink slips. Retailers like Macy’s ( M ) and Lululemon ( LULU ) are warning of sales and profits.

Add it all up and it doesn’t sound like much to celebrate.

But Wall Street is a funny place: good news is often taken as a bad sign, and vice versa.

Of course, it would be a big plus if the Fed can pull off the proverbial soft landing, slowing the economy without leading to a full-blown recession and/or a significant drop in corporate profits. But that’s a big if.

There is another possibility that the bulls are also clinging to: that there will be a recession, but a mild one, which also happens to be one of the most anticipated and recommended downturns in recent times. This is not the proverbial black swan. There is no “Lehman moment” to catch everyone off guard.

As long as the Fed can get inflation under control, investors may not be too worried about a recession anyway. At least that’s the ‘glass half full’ argument.

“Investors will find any recession less problematic if inflation is judged to be sufficiently contained and the Fed is prepared to initiate an appropriate monetary response,” Robert Teeter, managing director of Silvercrest Asset Management, said in a report.

Teeter added that falling inflation levels should boost stocks this year “even though earnings remain weak.”

But others see a problem with that argument.

“That is our main concern [investors] they assume that ‘everyone is bearish’ and therefore price declines in a recession will also be mild,” Morgan Stanley strategists said in a report.

Instead, Morgan Stanley strategists think investors may be surprised by how much stocks will fall if a recession hits. They noted that the market may not be appreciating “much weaker earnings.”

Investors may also be underestimating how far the Fed is willing to go with rate hikes to ensure that inflation finally begins to fall.

“Many investors were convinced of the strength of the US labor market. Yet … the Federal Reserve is determined to tighten monetary policy until that strength is eradicated — the recessionary clock is ticking,” Seema Shah, chief global strategist at Principal Asset Management, said in a report.

And Shah does not believe that the recession will be mild. She wrote after Friday’s jobs report that “a hard landing seems the most likely outcome this year.”

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