Markets and Economy What stock market pessimists may be missing

I have growing anecdotal evidence that some investors think the market advance is too good to be true. That’s largely based on conversations with friends and family. But it really struck me when several people felt the need to show me that a prominent financial TV host warned that one day we’ll have a crash.¹ That’s hardly news. All cycles end. That same pessimistic host also acknowledged that we don’t know when.

A quick scroll through my business-related social media feed reinforces the point. The usual pessimists are out in force, arguing that an inflation spiral is here, rates will keep rising, and the US debt story is finally unraveling. The long-awaited moment for the permabear has arrived. Or has it?

Sometimes facts get in the way

Compounding the skepticism is the nearly 200% two-month rise in the stock of a prominent memory-chip company,² helping to drive an 18.5% gain in the S&P 500 Index over the same period.³ To some, it feels unsustainable. Never mind that the company is only trading at 10x forward earnings.⁴ Compare that to the 18 prior periods when the S&P 500 rose by 18.5% or more over a two-month span. Returns were positive over the following six months in 16 of those instances, with an average gain of 10.6%.⁵ Sometimes facts get in the way of the naysayers’ good story.

Easing macro pressures

The skeptics will be right eventually. They usually are at some point. The issue is timing, and I think it’s likely not now. What makes the current pessimism particularly puzzling is that it’s happening at a moment when key macro pressures appear to be easing. Oil prices, interest rates, and inflation expectations have all shown signs of peaking.⁶ Yes, the most recent 3.3% core Personal Consumption Expenditures (PCE) reading moved in the wrong direction,⁷ but markets were already aware of that. We’ve also already seen the Federal Reserve (Fed) rate cuts priced out with little disruption.⁸

More importantly, the inflation breakeven has been drifting lower.⁹ Markets appear increasingly comfortable with the idea that inflation isn’t reaccelerating in a meaningful way. Geopolitical uncertainty remains. We don’t know the resolution of the Iran war or the path for the Strait of Hormuz. But markets tend to discount outcomes well before they’re realized, and there’s a growing belief that these risks will eventually stabilize.

So, what are the naysayers missing?

Earnings tell a strong story

First, earnings. US corporate earnings grew by 28% in the first quarter, well above the mid-single-digit expectations.¹⁰ Prices haven’t climbed at the same pace, meaning valuations have fallen.¹¹

Second, the discount rate. Markets have already adjusted to a less accommodative Fed path. Inflation expectations have generally been moving lower in recent days,¹² and it’s difficult to see the Fed raising rates in this environment.

Strong earnings growth alongside a Fed that’s on hold is a constructive combination in my view. If oil prices and interest rates continue to move lower together, it could also support a broadening in market leadership.

The pessimist often sounds smart. The narrative is compelling. Yes, this cycle will end. It always does. But it typically doesn’t end with credit spreads tightening¹³ and inflation expectations falling.¹⁴ The permabears will eventually have their moment and likely remind everyone that they were right. But when it arrives, markets may be higher than they have been today.