Based on the flood of bearishness that Street insiders and much of the financial news media have been expressing until very recently, it’s hard to believe that the Nasdaq is literally on the cusp of a new bull market. But it’s absolutely true.
On Feb. 1, the exchange closed at 11,816. That’s 17% above its 52-week low of 10,088. To get to the 20% increase considered the threshold of a bull market, the Nasdaq just has to increase about 290 points or 2.4%. And before trading began on Feb. 2, futures indicated that the Nasdaq would open 1.3% higher. So the Nasdaq may literally be just 1% from entering a new bull market.
There are many reasons for this development. First and foremost, as I’ve written for the last seven months, conventional wisdom underestimated the importance of a strong labor market. (By the way, the strong labor market was created primarily by the largely forgotten Paycheck Protection Program enacted during the pandemic). At the same time, the conventional wisdom was overestimating the Fed’s power. Those miscalculations led to a situation in which stocks fell much further than they should have, setting the stage for a bull market to emerge. And now, due to the strong labor market, many companies report outstanding financial results.
And finally, although I don’t think that the Fed is the sole determinant of the stock market’s direction (it’s time to bury the “Don’t fight the Fed” slogan once and for all), the fact that it’s easing up on its interest rate hikes and will stop raising rates soon is positive for stocks.
Here’s more information about why we are on the cusp of a new bull market.
The Vastly Underestimated Importance of the Strong Labor Market
While the Street’s focus was on inflation and the Fed, largely overlooked was that, for the first time in generations, many working-class and middle-class Americans were getting big raises and could easily get new jobs with much higher compensation.
In a June 2022 column, I wrote that “three factors primarily determine the spending levels of most American families: their jobs, their wages, and the extent of their confidence in the outlook of the first two items.” With those three factors quite positive, I hypothesized that American consumers’ spending would remain elevated, preventing a recession from occurring.
To illustrate the situation’s impact on the spending habits of typical middle-class Americans, I created a hypothetical middle-class American family. To make a long story short, although the family had to dip into its savings a bit because of inflation, family members’ wage increases and their strong confidence in their job security caused them to keep their spending levels high.
Put another way, high egg, bread, and gasoline prices will not meaningfully curtail the spending of middle-class American consumers who are getting significant raises and believe that their jobs are very secure.
Validating my argument, the economy grew 2.9% last quarter and is widely expected to expand again this quarter, while the major credit card networks are reporting that consumers’ spending has remained relatively resilient.
Overestimating the Fed’s Impact
Invented in 1970, the “Don’t Fight the Fed” slogan became a virtual religion on the Street, and that religion is still intact. But the 1970s and early 1980s, when the slogan likely started becoming dogma, were a time of low growth, lousy job markets, extremely high inflation for many years that had become deeply ingrained, and sky-high interest rates.
For example, in December 1976, the unemployment rate was 7.6%, and in Dec. 1981, it came in at a huge 8.5%. And in 1978, the Fed’s benchmark interest rate was 20%, versus today’s rate of around 4.75%! If the Fed raises rates in such an environment, stocks will do horribly because a combination of a terrible job market and huge interest rates will crush consumers.
But in 2022, interest rates were still historically below average for most of the year, the labor market was great, and inflation had only been problematic for a year or two. In such an environment, Fed rate hikes were not a big deal. (Believe it or not, before 2022, it had been over five decades since the economy was doing well, and the Fed had to raise rates to fight rising inflation).
Put another way, the direction of the Fed’s benchmark rate should be seen as one of several elements that determine whether stocks are likely to go up or down, not the “end-all and be-all” for equities.
And the direction of interest rates is not the most crucial determinant of the direction of U.S. stocks. The latter distinction belongs, in my opinion, to consumer spending. So maybe the new slogan should be “Don’t fight consumers.” And instead of spending so much time dissecting the Fed’s every word, the financial-news media, and Street analysts should intensively analyze the factors likely to impact consumer spending.
Strong Financial Results
Unsurprisingly, given consumers’ overall strength, many companies, defying the bears, have reported rather positive fourth-quarter results. In addition to the credit card networks, Tesla (NASDAQ:TSLA), GM (NYSE:GM), ServiceNow (NYSE:NOW), IBM (NYSE:IBM), Caterpillar (NYSE:CAT), casual-dining restaurant owner Brinker (NYSE:EAT), most airlines, General Electric (NYSE:GE), and AT&T (NYSE:T) are among the large companies that reported Q4 financial results which, in my opinion, can only be viewed positively.
And a high proportion of traditional banks., which in many ways signal the strength of the economy, also reported quite favorable earnings.
The Fed Is Not Going to Break Up the Party
Although the direction of the Fed’s benchmark rate is not the sole determinant of stocks’ performance, the central bank can derail the economy and stocks if it raises rates to ridiculously high levels.
But now the central bank is only raising rates by 0.25 of a percentage point per meeting, and it’s widely expected to stop hiking when its benchmark reaches around 5%. Moreover, pressured by newly ascendant doves on the Fed, Chairman Jerome Powell finally admitted yesterday that inflation is easing.
Given all these points, the market realizes something I’ve been predicting for a long time: the central bank will not trigger a recession and will not prevent stocks from rallying.
On the date of publication, Larry Ramer held long positions in TSLA and GE. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.