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NEW YORK (AP) – Wall Street on Friday ended a grueling two-year round trip beset by high inflation and worries about a recession that seems inevitable but has yet to arrive, ending a record I returned to the heights.
The S&P 500, the centerpiece of many 401(k) accounts and the main index used by professional investors to measure the health of Wall Street, rose 1.2% to 4,839.81. It erased the last decline since setting an all-time high of 4,796.56 in early 2022. During that time, stocks fell 25% as inflation soared to levels not seen since 1981, when Thelonious Monk and Ingrid Bergman were still alive.
Wall Street’s fears centered less on high inflation itself and more on: Medications traditionally used by the Federal Reserve to treat it. It’s high interest rates that put the brakes on the economy by making borrowing more expensive and driving down the price of stocks and other investments. And the Fed quickly raised its key interest rate from virtually zero to a range of 5.25% to 5.50%, the highest level since 2001.
Historically, the Fed has helped induce recessions through these rate hikes. Since the beginning of last year, there has been widespread speculation on Wall Street that the same thing could happen again.
But this time it was different, at least so far. The economy is still growing, unemployment remains extremely low, and there is growing optimism among American households.
“I don’t think this cycle is normal at all,” said Niladri “Neil” Mukherjee, chief investment officer of TIAA’s wealth management team. “It’s unique, and the pandemic introduced that unique element.”
Inflation has cooled from its peak two summers ago after surging as supply chain disruptions caused shortages due to COVID-19 shutdowns. So relaxed that the biggest question on Wall Street now is when the Federal Reserve will start lowering interest rates.
Such rate cuts can act like steroids for financial markets, releasing built-up pressure on the economy and financial system.
U.S. Treasury yields had already fallen significantly on expectations for interest rate cuts, which sharply accelerated stock market gains in November. The yield on the 10-year U.S. Treasury note fell to 4.13% on Friday, down sharply from 5% in October, the highest level since 2007.
Of course, some critics say Wall Street is once again ahead of the curve in predicting how quickly the Federal Reserve will start cutting rates.
“The market is addicted to rate cuts,” said Rich Weiss, chief investment officer of multi-asset strategies at American Century Investments. “They don’t understand it enough and they focus on it myopically.”
Ever since the Fed began its rate hike campaign in early 2022, traders have been quick to predict a rate hike was coming, only to be disappointed repeatedly as high inflation proves more stubborn than expected. If that happens again, we may need to reverse the big move of rising stocks and falling bond yields.
This time, however, the Fed itself has signaled when it will cut rates, with some officials suggesting it may be slower to begin cutting rates than the market expects. Traders are betting on a near-coin flip that the Fed will start cutting interest rates in March, according to data from CME Group.
“The truth is likely somewhere between what the Fed is saying and what the market expects,” said Brian Jacobsen, chief economist at Annex Wealth Management. “Until the two sides reconcile, it will continue to cause depression and rifts in financial markets.”
Some encouraging data was released Friday, following a preliminary report from the University of Michigan that suggests U.S. consumers’ mood is rising. Sentiment jumped to its highest level since July 2021, according to the report. This is important because consumer spending is the main driver of the economy.
Perhaps more importantly for the Fed, expectations for future inflation also appear to be entrenched among households. The big concern is that these rising expectations could create a vicious cycle that keeps inflation high.
Wall Street’s rally on Friday was driven by a big boost in tech stocks, which is typical during a rally.
Semiconductor companies rose for the second day in a row after major semiconductor manufacturer Taiwan Semiconductor Manufacturing Co. said it expects sales to beat analysts’ expectations this year. Broadcom rose 5.9% and Texas Instruments rose 4%.
Overall, the S&P 500 rose 58.87 points to its all-time high. The Dow Jones Industrial Average set its own record a month ago, rising $395.19, or 1.1%, to $37,863.80 on Friday. The Nasdaq Composite rose 255.32 (1.7%) to 15,310.97.
Last year, a select few Big Tech companies were responsible for much of the S&P 500’s rise. Seven of those stocks accounted for 62% of the index’s total return, according to S&P Dow Jones Indices.
Many of these stocks, including Microsoft, Apple, Alphabet, Nvidia, Amazon, Metaplatform, and Tesla, have caused a stir in the market over artificial intelligence-related technologies. The hope is that AI will lead to soaring profits for both the companies that use it and the companies that provide the hardware.
Investors may wish they had stuck with these stocks, nicknamed the “Magnificent 7.” But some companies, such as Tesla, are still below their all-time highs. The stock is still down 48% from its all-time high in November 2021.
Friday’s rally in the S&P 500 index is yet another example of how patient investors who diversify their investments across the U.S. stock market will eventually recoup all their losses. In some cases, it can take a long time, as in his lost decade of 2000-2009, when the S&P 500 plummeted through the bursting of the dot-com bubble and the global financial crisis. But given enough time, markets have historically reinvigorated investors.
Including dividends, investors with S&P 500 index funds are already back to breakeven a month ago.
Of course, risks still remain for investors. In addition to uncertainty about when the Fed will start cutting rates, it’s also not yet certain whether the economy will avoid recession.
Interest rate hikes are notorious for taking a long time to fully penetrate the system and can cause things to break down in unexpected places within the financial system.
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AP writers Matt Ott and Zimo Zhong contributed.
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