Markets and Economy Why the bull market has kept defying the bears

It has been just over a month since the S&P 500 Index reached a new all-time high on August 13.¹ Since then, investors have had to contend with what appears to be a daunting list of developments. Oil prices have surged by more than $20 per barrel.² The 2-year US Treasury yield has climbed roughly 60 basis points.³ The 10-year Treasury yield has risen by about 40 basis points.⁴ The Federal Reserve (Fed) has raised interest rates. The Bank of Japan has tightened policy. The Saudi East-West Pipeline was bombed, raising concerns about global energy supply.

And through all of that, the S&P 500 Index sits just 2.07% below its record high.⁵

That must be frustrating for the bears.

Perhaps they’ve been focusing too much on the long list of worries and not enough on the backdrop against which they’re unfolding. Markets don’t operate in a vacuum. They’re discounting mechanisms, weighing risks against economic and corporate fundamentals. Right now, those fundamentals have continued to look considerably better than many expected. Strong nominal growth⁶ and another round of outsized corporate earnings⁷ have helped offset a growing wall of worry.

Let's take a closer look at two of the market's biggest concerns.

Concern: Fed interest rate moves

Coming into the year, most investors expected lower interest rates. At one point, markets had been pricing in as many as three Fed rate cuts.⁸ The 2-year Treasury yield fell as low as 3.38% at the end of February, just before the conflict with Iran began. Today, that same yield stands near 4.73%.⁹

That’s a substantial reprice. In many respects, financial markets have already done much of the Fed's tightening for it, in my view.

What's notable is what hasn’t happened. Credit spreads have remained well behaved.¹⁰ US stock markets have largely absorbed the move.¹¹ Economic activity continued to expand.¹² If higher rates were creating meaningful stress across the economy, we’d expect to see those pressures emerging in broader financial conditions.

The reality is that this isn’t a particularly overleveraged economy. Consumers entered this period with relatively healthy balance sheets.¹³ Corporations largely termed out debt at lower rates.¹⁴ If rates rise but relatively few borrowers feel significant pain, then growth is unlikely to slow dramatically. That raises an important question. If markets have already absorbed a 135-basis-point rise in the 2-year Treasury yield from its February low, how much incremental damage will come if the Fed raises rates two more or three times? To me, it’s entirely possible that much of that concern has already been priced in.

Concern: Oil prices

The increase in energy prices is undoubtedly an inconvenient truth. Higher gasoline prices can act like a tax on consumers and weigh on confidence. But context matters.

The global economy has been far less energy intensive than it was decades ago.¹⁵ Coming into this year, US consumers had been spending a smaller share of disposable income on gasoline than at virtually any point in modern history.¹⁶ That doesn’t mean sustained high energy prices would be harmless. If today's levels persist long enough, growth could eventually slow. But sustain is the operative word.

Much of the market's fear has been tied to potential supply disruptions stemming from the conflict with Iran. Roughly 15 million barrels per day had been moving through the Strait of Hormuz.¹⁷ Alternative routes, including the Saudi East-West Pipeline, helped offset some of that risk. The bombing of that pipeline has clearly been a setback, but estimates suggest repairs could take days or weeks rather than months or years.

Meanwhile, the economic data continued to tell a resilient story. Retail sales have been holding up.¹⁸ Manufacturing activity remained firm.¹⁹ Earnings growth remained strong.²⁰

In other words, many of the market's worst fears at the outset of the conflict have materialized. Energy prices rose.²¹ Supply infrastructure was damaged. Central banks tightened policy. Bond yields moved sharply higher.²²

And yet, the S&P 500 remains just 2.07% below its all-time high.²³

To me, that feels less like a fragile market and more like one that has continued to climb a wall of worry. History has suggested that bull markets have rarely advanced in the absence of concern. They have advanced when fundamentals prove stronger than those concerns. To me, that appears to be exactly what’s happening.