Tech stocks are solely fueling all-time highs for the S&P 500. This surge has significantly contributed to prevailing market sentiment that a soft economic landing is possible, despite the looming threat of a recession. However, the question that investors and analysts must grapple with is whether this confidence is warranted given the complex economic landscape ahead.
There are still several challenges ahead that can reverse market momentum. Among them are:
- Credit Creation: Of critical concern is the stagnation of bank credit growth, which is currently at a near standstill. Credit is the lifeblood of economic expansion and its sluggish growth signals potential trouble.
- Rate Hikes Aftermath: The effects of previous rate hikes are still permeating through the economy. This lag could dampen growth and financial stability as the cost of borrowing remains elevated.
At first glance, high-level economic data suggests that the economy is holding steady. Consumer spending, employment, and GDP growth are among the metrics offering a reassuring picture.
However, a deeper analysis of the underlying fundamentals indicates that caution is still prudent. Economic resilience today does not guarantee immunity against future fiscal strains.
For this to look healthier, we need to see more than just tech sector dominance.
Small-Cap Stocks Must Shine for the S&P 500 to Keep Setting Highs
Technology stands out as the only sector reaching all-time highs, signaling a potential imbalance in the market. It’s more than just sectors, though, as small-cap stocks continue to lag the S&P 500. Their movement remains pivotal to confirm broadening breadth. Why? Because small companies, which are significant borrowers and include a higher proportion of zombie companies, are particularly sensitive to credit conditions. These companies might struggle to survive when faced with the need to refinance. Small-cap stocks are often seen as a barometer for broader economic health, especially in terms of credit risk and market breadth. The underperformance of these stocks is a stark reminder that large-cap averages are not discounting credit risk entirely.
Investors and policymakers alike must navigate through this period of economic uncertainty with a balanced approach. Monitoring credit growth, market breadth, and the performance of small-cap stocks will be essential in gauging the true health of the economy. While optimism in the markets is encouraging, we are now at the point where it must be confirmed by more than just one sector.
The Bottom Line
Bottom line? The market looks risk-on for now. Prevailing sentiment suggests that the economy might just achieve a soft landing, skirting around a recession.
However, numerous economic hurdles such as credit creation, the ongoing effects of past rate hikes, and small-cap underperformance highlight the need for caution. While optimism is a positive force in the markets, realism must be the compass guiding investment strategies and policy decisions. The months ahead will reveal whether the market’s current confidence is a prelude to sustained economic stability or a temporary reprieve before facing the challenges that lie ahead.
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.
