Last week’s robust Q4 GDP data provided a significant boost to investor sentiment, extending the bull run for the S&P 500. However, there’s more to the story than meets the eye, particularly when it comes to the Federal Reserve’s next moves and the overall health of the market.
What do I mean by this? When we go beyond large-cap tech stocks, it looks like three key themes are emerging beneath the surface:
- Value Stocks: Investors are increasingly trying to turn stocks that appear undervalued relative to their fundamentals. But momentum in value stocks is weak compared to that in growth stocks.
- Small-Cap Stocks: These smaller companies, often more sensitive to economic shifts, can’t seem to get out of their own way. They keep having fits and starts when it comes to showing any real outperformance.
- Cyclical Stocks: Industries that tend to ebb and flow with the economic cycle, such as manufacturing and consumer discretionary, are showing some strength.
What Q4 GDP Data Could Mean
These three trends indicate that investors believe the economy is set to recover and rebound, but they’re not going all in on that belief just yet.
Where does this leave the Federal Reserve? Despite positive sentiment, there’s a looming concern that investors might be underestimating the Federal Reserve’s willingness to maintain a dovish posture. A strong growth environment typically leads to higher interest rates, particularly at the long end of the yield curve. Yet, last week did not witness a significant rise in rates, which poses a question: Are we on the cusp of a policy shift?
The Federal Reserve has been in a delicate balancing act, aiming to stimulate the economy without reigniting inflation. But with the latest GDP data exceeding expectations, the Fed might have less room to maneuver than investors currently anticipate. A more hawkish turn could surprise the market, particularly if inflationary pressures reemerge.
Complicating this are the signals coming from the market itself. Consider the following:
- Equal-Weight S&P 500: This index, which gives equal importance to all stocks regardless of size, remains down in the year to date.
- Sectors and Markets: Five out of 11 S&P 500 sectors, the small-cap focused Russell 2000, and international markets, are lagging.
- Long-Term Treasurys: These safe-haven assets are also down, which could indicate skepticism about long-term economic stability.
If the market truly believed in a smooth economic transition was underway, we would expect to see a more democratic rally, lifting various sectors and stocks of all sizes.
That’s still not happening.
The Bottom Line
Bottom line? While the strong Q4 GDP reading has injected optimism, it’s not uniform. Market breadth remains weak, with gains heavily skewed toward mega-cap tech stocks (yet again). This disparity hints that confidence in the economic recovery may be more fragile than it appears.
Moreover, the potential for a policy shift by the Fed looms large. Investors seem to be banking on a continuing dovish stance, but this may be a precarious bet given the stronger-than-expected growth data. The March meeting will be critical in shaping market expectations going forward. Regardless, I believe these disconnects will resolve themselves, and likely in a more surprising (and potentially negative) way than the crowd can envision.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
