The Stock Rally Is Another Wall Street Head Fake

The year 2023 is off to a good start as far as stock market investors are concerned. For the week of January 3 – 6, 2023, the Dow Jones and S&P 500 both closed up 1.5%, and the NASDAQ rose 1.1%. Much of those gains occurred on Friday, January 6 when the Dow rose 700 points in a single day (up 2.13%) while the S&P 500 rose 2.28% and NASDAQ rose 2.6%.

As reported in this story, these gains were mainly attributable to Wednesday’s ADP report, which showed strong job creation, and Friday’s U.S. employment report, which showed that the unemployment rate has dropped to 3.5%, the lowest since 1969.

Combined with recent inflation reports that showed inflation coming down quickly, market analysts were quick to claim “Mission Accomplished” for the Federal Reserve. Their view was that the Fed has raised interest rates enough to slow inflation without causing a recession.

This was the “soft landing” that many had been hoping for. It was time for the Fed to stop raising rates, and let inflation take care of itself, while enjoying the benefits of strong job creation and a low unemployment rate.

This prospect of a halt in interest rate hikes was enough to get the stock market to the liftoff stage. Unfortunately for stock investors, the economic news is not nearly as good as the headlines would have you believe.

The same employment report that showed 3.5% unemployment also showed that real wages had declined, hours worked had declined, and job creation had declined. Unemployment figures are a lagging economic indicator. So, the fact that these negatives are now showing up does not preclude the fact that we are already in a recession.

Other indicators show that industrial output, services output, and housing prices are in decline. World trade is contracting (data on trade surpluses and deficits is less important than data on trade volume, which shows sharp declines). Yield curves are inverted, which means that markets expect interest rates to decline in the near future because of economic contraction, disinflation or both.

At the same time, the Fed will continue on its path of rate hikes (partly because of the low unemployment rate), which will only make the recession worse. A new wave of taxes and regulations coming from the Biden administration will slow growth even further.

Stocks may continue to rise in the short run based on the soft landing meme. Meanwhile, investors should take gains, increase cash allocations, and get ready to weather a severe storm.

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