When Bond Yields Dropped, the Everything Rally Kicked Off

When Bond Yields Dropped, the Everything Rally Kicked Off
When Bond Yields Dropped, the Everything Rally Kicked Off

Summary

Stocks, bonds, crypto and gold are surging, sparking worries of a fleeting sugar high.

Investors spent most of 2023 fretting about inflation and interest rates. Now they are snapping up everything from stocks and bonds to crypto and even gold.

The simultaneous surge across assets has sparked debate about whether the “everything rally" marks the arrival of a lasting bull market—or just a fleeting sugar high at the end of the Federal Reserve’s tightening cycle.

At the start of the year, interest rates were rising and Wall Street was bracing for a recession. Major stock indexes rallied, driven largely by the “Magnificent Seven" group of technology stocks, but most other sectors languished.

Now bond yields are plunging, and investors sense the Fed’s fight against inflation is winding down. The drop in yields has led to a broad rally: Some of the market’s most beaten-down sectors, including property stocks and regional banks, are leading the way.

“The economy is slowing, but it’s not cracking," said Jason Draho, head of asset allocation Americas at UBS Global Wealth Management. “All of which means the concern about the Fed hiking any more, that’s off the table."

The S&P 500 has advanced 12% from its Oct. 27 low to reach its highest level of 2023 and extend its year-to-date gains to 20%. The blue-chip Dow Jones Industrial Average, which had lagged behind for much of the year, is less than 2% from its January 2022 record. And the Nasdaq Composite, which fell farther than the other indexes on the way down, has paced its peers with a 38% gain in 2023.

In the bond market, the yield on the benchmark 10-year U.S. Treasury note has fallen to 4.244% from 5.021% on Oct. 23 as prices have risen. U.S. government bonds returned 3.44% in November, marking their third-best monthly performance since 1989, according to UBS.

The rally has extended to cryptocurrencies. Bitcoin traded above $44,000 last week for the first time since April 2022. This time the money followed the trade. Digital asset fund inflows have totaled $1.76 billion over the past 10 weeks, according to data compiled by crypto asset manager CoinShares. That is the highest level since October 2021, when the first bitcoin futures-based exchange-traded fund launched in the U.S.

Gold futures, which typically rise in times of stress, reached a record in December, a sign that investors are growing more confident that interest rates have peaked.

Even Wall Street deal making, which has been largely dormant since 2021, recently perked up. Alaska Air and drugmaker AbbVie unveiled plans for major acquisitions at large premiums, while the fast-fashion company Shein filed for an initial public offering.

A busy week ahead will help investors gauge where the economy and markets are likely headed next. The consumer-price index for November will be released Tuesday, while the Fed’s next policy meeting will conclude Wednesday.

Although the stock rally has stalled in December, skepticism among individual investors has melted. In a weekly survey released Thursday by the American Association of Individual Investors, nearly half of participants said they expect markets to rise over the next six months, well above the survey’s historical average reading.

At the start of November, just 24% of respondents were bullish and half were bearish. Pessimism at the end of that month reached the lowest level since 2018, the survey said.

“I think this rally has legs and could last into 2024," said Lauren Goodwin, economist and portfolio strategist at New York Life Investments. “My concern is this Fed relief rally is very typical late in the economic cycle."

Some of the sectors punished by higher interest rates have rallied the most. The S&P 500 real-estate sector advanced 12% in November, its best monthly performance since 2011. An exchange-traded fund of home-builder stocks recently touched a record, even as higher interest rates make homes less affordable for average consumers.

The beleaguered regional-banking sector is shaking off the impact of the crisis that wreaked havoc in March. The KBW Nasdaq Regional Banking Index has gained 22% since the end of October.

Behind the rally is growing confidence that the Fed will be able to achieve a “soft landing," meaning the central bank can bring inflation to heel without triggering a major slowdown. The consumer-price index rose 3.2% in October from a year earlier, less than Wall Street had expected.

“Economists who’ve said it’s going to require very high unemployment to get this done are eating their words," Treasury Secretary Janet Yellen said last week.

Investors appeared to find what they were looking for in Friday’s jobs report. U.S. employers added 199,000 jobs in November, the Labor Department said, slightly higher than economists had forecast. Job openings fell in October to the lowest level since 2021. Stocks rallied and bond yields rose Friday in response.

Traders in interest-rate derivatives are pricing in a 98% chance that the central bank will leave its policy rate unchanged at this week’s meeting, according to CME Group’s FedWatch tool. They are pricing in a 4% likelihood that the Fed will cut rates in January and a 46% chance in March.

By the end of next year, interest rates are expected to be about a full percentage point below current levels.

Skeptical investors and strategists don’t expect an imminent reversal. But they point to concerns that inflation could tick higher once again, or the long-feared recession could finally materialize.

“I just think the Fed is not sure enough that they’ve killed the inflation dragon to cut rates," said Barry Bannister, chief equity strategist at Stifel.

Plus, stocks still look relatively pricey compared with history. The S&P 500 trades at about 22 times earnings over the past 12 months, according to FactSet, slightly above the 10-year average.

“The people who are jumping up and down about a soft landing, they might be right," said Justin Simon, portfolio manager at Jasper Capital Management. “But to me, that’s the same thing as getting excited about transitory inflation."

Vicky Ge Huang contributed to this article.

Write to Charley Grant at charles.grant@wsj.com

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