When Markets Are This Hot, Should You Jump In?

The traditional favorable start to financial markets in 2023, due to investor fund inflows that typically accompany the new year, has been turbocharged by data pointing to a greater possibility of a soft landing for the U.S. economy and, most recently, the signals coming out of the Federal Reserve.

The generalized price rally has been so quick and so big for both stocks and bonds that it raises an interesting question for underinvested investors who have not yet put their money to work. What they should do correlates closely, but not entirely, to their economic and policy views.

Most of the recent macroeconomic data have been better than consensus forecasts. The resulting mix of declining inflation indicators and less worrisome growth developments has tipped the balance of risks somewhat more toward a soft landing and away from the hard landing characterized by a recession or stagnation.

That is music to the ears of markets because it enables a mutually supportive price rally for stocks and bonds. It is reinforced by the view that, because of such economic developments, the Fed will not have to raise interest rates much higher, if at all, nor will it have to keep the elevated rates unchanged for the remainder of 2023.

Indeed, the markets this week increased their expectations for rate cuts later this year, further fueling the rally in stocks and other risk assets.

Eye-Popping Moves

The resulting moves in markets are eye-popping. Barely a month into the year, the S&P 500 Index is up almost 9%. Internationally, European markets have done even better, with the main indexes up 11% to 14%, as have emerging markets, which have gained roughly 10%.

The typically more volatile assets have also soared, with the technology-heavy Nasdaq Composite Index up more than 16% and Bitcoin gaining more than 44%. Fixed income has not been left out, with strong gains for the riskier and more volatile segments such as high-yield bonds, which are up 5%.

What to Do?

This sharp, rapid and generalized rally confronts the underinvested with a delicate balance: Should they jump into a rally that has already met quite a few analysts’ market forecast for the year as a whole, or should they wait for more attractive entry points?

An important part of the answer depends on their economic and policy views.

Underinvested investors would be inclined to join the roaring rally if they expect economic growth and jobs to hold up and inflation to come down solidly and consistently toward the Fed’s 2% target — that is, extrapolating the favorable data for the last few months.

They would also be betting on this macroeconomic configuration to persuade the Fed to pause interest-rate increases either now or after one more hike and then cut in the second half of the year.

In doing so, they would be discarding indicators that would favor the alternative — that of waiting for better entry points. Such indicators include still-worrisome forward-looking economic data, including purchase managers’ indexes and layoff announcements, as well as the Fed’s consistent forward policy guidance.