US Stock Market Rebounds Strongly, but Cracks Are Emerging. Can the US Economy Still Achieve a Soft Landing?

According to Dolphin Research APP, the U.S. stock market has shown a favorable upward trend this year. As of Friday's close, the S&P 500 index has accumulated a nearly 16% increase, while the Nasdaq index has seen a cumulative increase of nearly 31%. However, this strong upward trend is largely driven by the AI boom, and people's confidence in U.S. economic growth is not as strong as the stock market's performance suggests. The performance of banks and industrial companies is disappointing, with growth barely maintained in 2023. The Dow Jones index, which has lower weights for large-cap and tech stocks, has seen a much lower increase this year compared to the S&P 500 and Nasdaq indexes, at only 4.44%.

The performance of small-cap stocks is also a cause for concern, as their charts show unsettling signals that have rarely been seen in the past 20 years. The Russell 2000 index has lagged behind the index of the 1,000 largest stocks for the second consecutive month, potentially marking the second worst annual performance since 1998.

The upward trend in the U.S. stock market driven by large-cap and tech stocks means that only a small number of investors have benefited from the AI boom, while most people are still uncertain about the direction of the economy. Matt Miskin, Co-Chief Investment Strategist at John Hancock Investment Management, said, "There are still cracks beneath the surface of the market, with poor performance in financial stocks and small-cap stocks. You can't see the breadth." "Frankly, it looks more like a stir within the market, with the top players performing the best and the rest relatively weaker."

All of this brings to mind the poor performance of small-cap stocks in 2021. Historically, small-cap stocks have led the way during economic recoveries and have been sold off during periods of economic pressure. Given that most of the sales of small-cap companies are domestic, investors hope to find clues about the health of the economy from these stocks. Although there is increased confidence in the Fed's ability to achieve a soft landing, there is still no consensus on the weak points of the market.

Many smaller companies have not participated in the upward trend of the U.S. stock market this year. Liz Ann Sonders of Charles Schwab pointed out that since the strong rebound of the S&P 500 index from its low point in October last year, 11 months have passed, but only about 40% of the stocks in the Russell 2000 index are trading above the 200-day moving average. In comparison, during the period when the U.S. stock market emerged from its low point in 2020, over 90% of the stocks in the Russell 2000 index were above the 200-day moving average.

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Many institutions and market participants, including Goldman Sachs, are optimistic about the prospects of the US economy. The GDPNow model in Atlanta also shows that the US gross domestic product (GDP) will grow by 4.94% in the third quarter, slightly lower than the 5.57% predicted a week ago.

However, Matt Maley, Chief Market Strategist at Miller Tabak + Co., said, "The stock market is sniffing out something that the current data is not telling us. Remember, most data, such as retail sales and inflation, are lagging indicators." "With interest rates reaching a 15-year high and student loan forbearance ending in a few weeks, it appears that consumers will no longer be able to provide the same level of economic momentum as they have for most of this year."

Michael Hartnett, the chief strategist at Bank of America, also urged defensive-minded clients to buy assets that have already absorbed the rapid decline in economic growth, such as regional bank stocks and small-cap stocks. The strategist said, "Investors should be long on assets that have priced in a 'hard landing' because they will suffer less in a potential economic downturn. And if there is no recession, they will have significant upside potential."

As one of Wall Street's most bearish strategists on US stocks, Morgan Stanley's Michael Wilson issued another warning recently, calling for investors to focus on a "late-cycle investment portfolio" consisting of defensive stocks, industrials, and energy stocks. He reiterated his view that the stock market has not yet reflected the risks of an economic recession. He said, "As is typical during this period, price-to-earnings expansion has exceeded fair value determined by macro fundamentals, which poses a burden on growth reacceleration and/or incremental policy support."