The stock market's surprising 2024 rally faces a crucial test: key economic data releases poised to reveal whether inflationary pressures are simmering or subdued. These reports hold immense power to either validate the current optimism or trigger a market correction.
Jobs data and the Consumer Price Index (CPI) are always market movers, but this time around, the stakes are even higher. January's figures, with their unexpectedly robust job growth and firming inflation, sent shockwaves through the market, disrupting months of encouraging data suggesting a cooling labor market and declining inflation.
This positive trend had fueled widespread belief that the Federal Reserve could tame inflation without triggering a recession, propelling stocks to record highs. However, February's economic releases caused some turbulence, raising concerns that the January data may not be a blip, but a harbinger of future trends.
Investors are keen to see if the data confirms January's trend. A repeat performance could deliver a significant blow to the market, jeopardizing hopes for multiple interest rate cuts this year and a smooth return to the Fed's 2% inflation target.
"One month can be forgiven, especially January," explains Larry Adam, Chief Investment Officer at Raymond James. "But a second month solidifies a pattern, and that's when things get dicey."
The data needs to strike a delicate balance – neither too hot (indicating persistent inflation) nor too cold (signaling a potential recession) – to maintain investor confidence. By all metrics, stocks are currently trading at historically high valuations. This might be justified if the economy embarks on an expansion, but becomes less defensible if a recession looms.
Signs of market unease are already evident. The Dow Jones Industrial Average suffered its biggest two-day decline since October this week. Investors are particularly nervous about the valuations of large tech stocks that spearheaded the 2023 rally.
While some tech giants like Nvidia continue to soar, others have slumped significantly. This has fueled concerns about a potential tech bubble similar to the one witnessed in the 1990s.
Pessimists highlight both the elevated valuations and lingering inflation worries. Brent Schutte, Chief Investment Officer at Northwestern Mutual Wealth Management, sees parallels to the 1990s tech bubble. He points out that while the Fed's preferred inflation measure was trending downwards before January, other metrics suggest a potential upward tick.
"The market is still pricing in a soft landing," says Schutte. "But the fly in the ointment remains inflation, which I believe is still elevated and moving in the wrong direction."
Despite these concerns, many investors and economists remain optimistic. Economists predict a moderate job growth figure for February, and a steady unemployment rate. They also anticipate a decline in core inflation (excluding food and energy) compared to January's figures.
While there's a risk that inflation may not cool as quickly as anticipated, many investors remain confident in the Fed's ability to manage the situation and bring inflation down to allow for rate cuts later in the year.
Furthermore, investors have more tools at their disposal compared to the past. Rising interest rates have led to higher bond yields, offering a potential hedge against a recession. Additionally, the recent pause in rate hikes provides some relief and reduces the risk of further significant losses.
The upcoming data releases will be pivotal in determining the trajectory of the stock market. A positive outcome could solidify the current rally, while negative data could trigger a correction. Investors will be glued to their screens, waiting to see if the economic data validates their optimism or compels them to adjust their strategies.
