Wall Street Sobers Up After December’s Rally

Wall Street’s longest winning streak in almost 20 years is close to ending, as stock investors’ celebrations over slowing inflation and the potential for cuts to interest rates have been dialed down as traders air caution over the lingering risks to the market.

The S&P 500 index is on track for a weekly loss — about 1.7 percent as of Thursday afternoon — that would end nine straight weeks of gains, the market’s longest winning streak since January 2004. The Nasdaq Composite, chock-full of tech stocks that soared in 2023, has inched lower for the past five days, a string of daily losses not seen since October 2022.

Coming on the heels of such a sharp rally, analysts and investors said that for the time being the moves signaled only a mild pullback, rather than the start of a more severe downturn. Investors’ unbridled optimism had pushed the S&P 500 almost 14 percent higher in the final two months of the year, to within a whisker of a new high.

Alongside caution that stock market valuations had risen too far too quickly, investors newfound sobriety this week was underpinned by a rethink about when the Federal Reserve will begin to lower interest rates — cuts that could bolster stock prices, corporate profits and consumer spending. Heading into the end of 2023, investors were betting that rate cuts could start as soon as March.

Minutes of the Fed’s last meeting in December, released on Wednesday, confirmed perceptions that the central bank’s stance has shifted, with policymakers acknowledging a slowdown in inflation that likely means an end to further interest rate increases. But the minutes suggested policymakers are intent on keeping rates elevated until they are more confident inflation is under control, putting those bets on a rate cut in the coming months under pressure. That in turn has weighed on stocks.

On Friday, new data showed that labor market remained strong in December, cementing confidence in the economy’s resilience but also stoking concerns that inflation could yet reignite as wages continued to rise.

“The market has got a bit ahead of itself,” said Cayla Seder, a macro strategist at State Street, noting the risk that the slowdown in inflation could still reverse course. “There was so much optimism going into the end of the year.”

The S&P 500’s early slide marks its worst start to a year since 2015, though analysts cautioned about drawing strong conclusions from just four days of trading.

Many of the stocks that propelled the market higher last year have been the anchor weighing it down in 2024. All of the so-called magnificent seven stocks, which include the biggest companies in the market that have an outsized impact on returns, rank among the worst performers so far this year.

Collectively, Apple, Amazon, Microsoft, Nvidia, Tesla, Google’s parent Alphabet and Facebook’s parent Meta are responsible for nearly 60 percent of the S&P 500’s drop since Jan. 2. Without them, the index would have fallen less than 1 percent.

Apple, down 5.5 percent this week, has come under sustained pressure after two analysts downgraded their outlook for the company, pointing to falling iPhone sales that have contributed to contracting revenues.

Some analysts say that stock prices could fall further. While investors have dialed down bets on a rate cut coming in March, they are still expecting that a gradual slowdown in the economy will give the Fed license to cut borrowing costs by 0.75 percentage points by the end of July — as much as the central bank forecast in December for the whole of 2024.

If the economy proves stronger than anticipated, the central bank is likely to hold rates higher for longer, disappointing investors; while a sharp deterioration in the health of the economy could result in rate cuts, but for more worrying reasons.

“It’s all very Goldilocks,” said George Goncalves, chief macro strategist at MUFG Securities. “It doesn’t sit right with me.”

A rise in longer-term borrowing costs, underpinned by the rate paid on government bonds, could also unsettle stock investors, after a stunning rally late last year dragged the yield on the 10-year Treasury down by roughly a percentage point to around 4 percent. Some bond traders surveyed by J.P. Morgan came into this week betting on a reversal of some of that move, and Friday’s jobs data has already helped to push yields higher.

“One of the big risks of leaning into a Fed relief rally is that after a couple of months, investors usually realize that the Fed is pulling back on interest rate hiking policy because they are seeing growth slow,” which tends to be “less constructive” for the stock market, said Lauren Goodwin, an economist at New York Life Investments.

For many analysts, though, a modest pullback in the market was warranted after the searing rally at the end of 2023, with most stock market prognosticators still forecasting a rise in the S&P 500 over the next year.

Roger Aliaga-Diaz, an economist at Vanguard, said that the balance of risk had tilted toward a “rosy scenario” while “ignoring all the risks that are, in our view, still there.”

“We are not out of the woods in terms of inflation,” he warned.