Bull market or fool's market? Investors say it's likely the latter

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It's hard to believe that the economy is on the brink of recession when the stock market has made such incredible strides.

The S&P 500 index closed at 3,666.77 on the 16th of June 2022. This was a result of persistent inflation, interest rate increases by the Federal Reserve and geopolitical tensions.

The broad-based Index is 4,409.59 at the close of June 16, 2023. This represents a gain of roughly 20% from the previous year despite the collapse of regional banks and the Fed’s ongoing battle against inflation.

Mega-cap tech shares that were hammered by rising interest rates 2022 are also seeing a big boost this year. Apple shares closed at a record high of $186.01 on Thursday, up from $135.43 one year earlier.

The S&P 500 has increased by approximately 15% for the year. The Dow has gained about 3.5%, and the Nasdaq composite has increased by 30.8%.

Investors say that the recent acceleration of the rally is a sign that there will be some pain in the future.

Amanda Agati is the chief investment officer of PNC Financial Services Asset Management Group. She said that 'the market has been acting delusionally'. "Much of what is happening right now could very well be the last gasp, before we tip into recession."

There are already signs of cracks forming, and they could widen soon. On Wednesday, the Federal Reserve held rates at their current level but said that they could increase rates two more times this year. Investors quickly discounted the Fed's hawkish signals and stocks rose again by Wednesday evening. The stock market fell slightly on the Friday but ended up with a positive week.

There are a few signs that indicate the market, for the moment, is on fire.

S&P 500 hits new highs and bull market territory

Late May, the passage by Congress of the debt ceiling agreement (later signed by President Joe Biden into law) and the blowout quarter for chipmaker Nvidia helped push mega-cap tech stocks higher, helping them break out of the trading range that they had been stuck in since months.

S&P 500 entered a bullish market earlier this month, with a gain of over 20% from its October low. The broad-based Index closed Thursday at its highest level in April 2022.

Market expansion is improving

The market breadth has improved in recent months as the S&P 500 rally has spread from tech stocks into other sectors of the stock market, including industrial, financial and materials.

This is a good sign for investors who are worried that the S&P 500 gains this year were dominated by tech mega-cap stocks. The S&P 500 has been buoyed by a flight of safety in anticipation of economic uncertainty, and artificial intelligence excitement.

Tech stocks' record run

Apple shares closed Thursday at a record-high, bringing them closer to a market capitalization of $3 trillion. The stock had hit an intraday high a week before, when the company announced its mixed reality headset Vision Pro during its annual developers conference.

The shares of the tech giant are up by about 42% this year.

Dan Ives of Wedbush Securities expects Apple to reach $240 per share by summer next year and a $4 trillion valuation closer to 2025. He cites the hype around AI and the possibility of a record-breaking iPhone model due to be released this fall.

Ives stated that 'there's no better tech stock to buy than Apple... even though the economy is still somewhat cloudy'.

Microsoft's shares closed at $348.10, a new all-time record, on Thursday.

Next rally test

Investors say that despite some bullish signs on the market, the math doesn't add up to a sustained rise -- especially when a recession could be looming.

While the market has gained in breadth over the past few weeks, the majority of the gains are still attributed to the mega-cap technology stocks, which could leave the rally with shaky legs. Wall Street is also concerned that the recent market run has been overdone.

Richard Steinberg is the chief market strategist of The Colony Group. He said that some of these moves are like Icarus flying to close to the Sun.

The yields on the 2-year and 10 year Treasury bills remain inverted. This is a trend that historically has preceded economic recessions.

Agati says that the next Fed interest rate decision will be the next test of stocks. Jerome Powell, the chair of the Fed, said on Wednesday that the meeting in July will be "live," meaning that the decision is up for discussion.

Agati said, 'We believe the Fed will tighten its policy again in July. This may be the catalyst for a correction of the market.

Some investors are still bullish even though they anticipate some short-term pain.

Sylvia Jablonski is the chief executive officer and chief investment office of Defiance ETFs. She said, 'I believe that we are likely to end up rather than down this year.' I don't think that we will get an additional 20%, 30%, or anything like that from the Nasdaq.

Stocks rise despite Fed's hawkish stance

At its meeting in June, the Federal Reserve was more hawkish that expected. Investors did not seem to be concerned.

Last Wednesday, the central bank paused rates and said it may raise rates twice more this year. Investors ignored the message and stocks continued to rise in the days following.

Fed Governor Christopher Waller, and Richmond Fed President Thomas Barkin both said on Friday that interest rates need to be raised more by the central bank to curb inflation.

We're seeing some effects of policy rates on certain parts of the economy. Waller stated that the labor market was still strong but that core inflation had not moved. This would require more tightening in order to bring it down.

Stocks fell on Friday after the Fed's tough words. All three major indices gained this week.

Sarah Henry, portfolio director at Logan Capital Management, explains that the market rallied despite the Fed sending hawkish signals. Wall Street decided that one or two rate increases are not much different.

Henry stated that the markets will not care if the Fed increases rates by one or two times. They are more concerned with the market's current rate hikes. The Fed's ability to predict its rate decisions is more important at this stage than the incrementality.

Henry says that a recent series of robust economic readings have investors convinced that, even if a recession does occur, it will be brief and shallow.

Here are some of those data:

The May employment report is hot. The unemployment rate increased more than anticipated, from 3.4% to 3.7%. Consumer Price Index for May shows a cooling down. CPI grew 4% in the year that ended May. This is the lowest annual rate since March 2021. Report on the Producer Price Index for May shows a cooling. PPI reported that annual producer inflation measured 1.1% in the 12 months ending May. This is the 11th consecutive month of cooling. The University of Michigan consumer expectations survey shows a strong sentiment. The consumer's inflation expectations for next year fell for a second consecutive month. They dropped to 3.3% from 4.2% in early June.

According to Paul Eitelman of Russell Investments, the rally's momentum is also a result of positive investor sentiment. This includes secular trends such as artificial intelligence, which have driven megacap stocks to unprecedented heights in 2018.

Eitelman stated that 'it almost feels like there is only good news in the market right now. We rallied because of a Fed that was hawkish.' We're noticing a significant shift in the market's psychology.

Investors could still be ahead of themselves. He said that the message from the Federal Reserve to equity markets should be cautious.

Wednesday: Federal Reserve nominees hearings

Thursday: Existing Home Sales for May from the National Association of Realtors. Jobless Claims, Mortgage Rates and US Leading Economic Indicators for May. Federal Reserve Chair Jerome Powell delivers his semi-annual monetary report to the Senate Banking Committee.