Why is Wall Street suddenly cheerful?

Even though it is still early January, Wall Street has already seen a pendulum swing in 2023 from despair to happiness, to quote Billy Joel.

In contrast to the poor performance of last year, stocks are off to a good start this year. The Dow is still up more than 1% so far this year even if it lost more than 110 points, or 0.3%, to end Monday’s session. While the Nasdaq increased by 0.6%, the S&P 500 concluded the day down 0.1%. But since the end of 2022, each of those two indices has increased by around 1.5%.

Even the CNN Business Fear and Greed Index, which examines seven market attitude indicators, is currently edging closer to Greed zone after spending the most of the previous two weeks mired in Fear.

But why, all of a sudden, is Wall Street so upbeat? Still, I wouldn’t say the headlines are all that terrific.

Yes, the market welcomed Friday’s employment data since it showed that pay growth was moderating, which would result in further easing of inflationary pressures and more gradual Federal Reserve rate increases. However, it also demonstrated that the rate of employment growth is decreasing, which may be a sign of an impending recession.

The newest statistics from the Institute for Supply Management revealed, however, that the services sector, a significant driver of the US economy, shrank last month. And a number of well-known businesses in the internet, consumer, financial services, and yes, media sectors, have made significant layoff announcements or revealed intentions to issue pink slips. Several retailers, including Macy’s (M) and Lululemon (LULU), have issued profit and sales warnings.

When you add it all up, it doesn’t sound like a reason to celebrate. However, Wall Street is an odd area where positive news is frequently interpreted negatively and vice versa.

It won’t be simple navigating a soft touchdown.

A gentle landing by the Fed, slowing the economy without triggering a full-fledged recession and/or a sharp decrease in corporate earnings, would undoubtedly be a great bonus. That’s a huge if, though.

The likelihood that there will be a recession, although a light one that also happens to be one of the most widely anticipated and foreshadowed downturns in recent memory, is another reason bulls are holding to. This is not the fabled black swan. There isn’t a “Lehman moment” to surprise everyone.

Investors might not be very troubled about a recession anyhow, as long as the Fed can keep inflation under control. That is the “glass is half full” argument, at least.

According to Robert Teeter, managing director of Silvercrest Asset Management, “Any recession will be regarded by investors as less serious if inflation is deemed to be properly restrained, and the Fed is poised to undertake an effective monetary reaction.”

Teeter continued, “Even if earnings remain sluggish, lowering inflation levels could benefit equities this year.”

Others, though, perceive a flaw in that justification.

According to Morgan Stanley strategists, “our fear is that most [investors] are thinking ‘everyone is gloomy’ and, thus, the price decline in a recession is likewise likely to be minimal.”

Instead, the strategists at Morgan Stanley believe that if there is a recession, investors may be astonished by how much lower equities go. They stated that “far worse results” may not be priced in by the market.

Investors could possibly be underestimating the Fed’s willingness to raise rates significantly in order to ensure that inflation eventually begins to decline.

“The robustness of the US job market has comforted many investors. The recession clock is ticking, but the Federal Reserve is committed to tighten monetary policy until that strength is eliminated, according to Seema Shah, chief global strategist at Principal Asset Management.

Shah also doesn’t think the recession will be minor. “A harsh landing seems to be the most likely consequence this year,” she wrote following Friday’s jobs data.

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