Stock Market Rallies: Causes and Characteristics

The stock market has been on a remarkable run, with major indices like the Dow Jones, S&P 500, and Nasdaq Composite reaching record highs. This surge in stock prices is not just a fleeting phenomenon but is driven by several key factors that are shaping the market's trajectory. In this article, we will delve into the causes and characteristics of the current stock market rally, using the latest figures and data.

1. Strong Employment Report

One of the primary drivers of the recent stock market rally is the surprisingly strong U.S. jobs report. The latest employment data showed a significant gain in American hiring, which has bolstered investor optimism about the economy's resilience. This report not only vindicated equity proponents but also led to a reevaluation of interest rates bets, as the robust labor market underscores the vigor in domestic investment and consumption cycles.

2. Interest Rate Cuts

The Federal Reserve's decision to cut interest rates has been a significant catalyst for the stock market rally. The half-point rate cut, historically reserved for recession or market crisis scenarios, has provided a boost to the economy. This move has been accompanied by a decrease in bond yields, which has made equities more attractive to investors. The probabilities for further rate cuts, particularly at the November meeting, remain high, with a 84% chance of a 25-point cut.

3. Macroeconomic Data

Strong macroeconomic data has also contributed to the market's upward trend. Recent reports indicate that growth in the US economy, real estate, healthcare, and other service sectors has accelerated to its highest level since February 2023. Additionally, private-sector job numbers and measures of the services sector have painted a rosy picture of the U.S. economy, further supporting the rally.

4. Corporate Earnings Expectations

Robust corporate earnings expectations are another key factor driving the stock market rally. With companies reporting strong quarterly earnings, investor confidence has been bolstered. The S&P 500's recent all-time highs in October are historically a good omen, as the index tends to climb another 5% on average through the end of the year. This scenario has played out nine times before, with only two exceptions where the market didn't keep rising.

5. Utility Stocks Performance

While the broader market has been on a tear, utility stocks have emerged as an unlikely leader. The continued increase in data, compute, cloud migration, and AI has fueled growth in data centers and the electricity needed to power them. This new wave of energy demand has driven utilities to outperform the market, with the sector returning 25% in total return year-to-date, second only to tech stocks.

6. Oil Prices and Geopolitical Tensions

Oil prices have been a mixed bag, influenced by geopolitical tensions in the Middle East. The recent escalation between Israel and Iran has led to an increase in crude oil prices, which could disrupt oil shipments to China economy and impact neighboring countries crucial to crude supply. However, ample oil inventories have helped stabilize prices, and the current levels are not as high as they were last month.

Characteristics of the Rally

1. Risk-On Sentiment: The rally is characterized by a risk-on sentiment, where investors are increasingly optimistic about the economy and are willing to take on more risk. This is evident in the strong performance of small-cap companies and tech stocks, which have led gains in recent days.
2. Valuations: While valuations for the S&P 500 are rich, with a 35% surge over the last year, utilities remain attractively valued. The sector is trading at a 13% discount to the S&P 500 and is only slightly above its own 5-year and 10-year averages. Falling interest rates could further boost utilities as their dividend yields become relatively more attractive.
3. Historical Trends: Historically, when the S&P 500 surges more than 20% in the first nine months, it tends to finish the year even stronger. This scenario has played out nine times before, with only two exceptions where the market didn't keep rising. Similarly, the Dow Jones and Nasdaq Composite have shown strong trends, with the Dow adding about 5% in the final quarter under these circumstances and the Nasdaq tacking on another 6.6% in the last three months.

Conclusion

The current stock market rally is driven by a confluence of positive factors, including strong economic data and investor sentiment. While geopolitical risks and potential market fluctuations remain, historical trends suggest the rally could continue. However, investors should exercise caution and diversify their portfolios.