The first few weeks of the new year could not have been more different. 

The key US benchmark, the S&P 500, is now 15% up from its October lows, with the tech-heavy Nasdaq 17% higher in a couple of weeks. 

Riskier junk bonds have appreciated considerably in the last month, with yields over 1% lower, while Bitcoin – the standard-bearer of risk on sentiment – has had its best January in history, up almost 40%. 

The local JSE has not been left out of this rush of blood to the head. 

On the back of soaring bourse heavyweights Naspers and Richemont, the Top 40 is up almost 30% from its lows in September. Markets have experienced a “flight-to-shite”, according to Robin Wrigglesworth of the Financial Times.

What, if anything, has changed to create this sudden reversal? And can it last? Or is this just another iteration of the bear market rally last seen between June and August, when the S&P 500 appreciated an eerily identical 15%?

The data coming out of the global economy are mixed, and Friday’s US jobs number did not help the confusion. 

The US economy added half a million jobs in January, blasting through expectations and making any recent labour market cooling look very marginal indeed. And yet, outside of the jobs market, things are not looking good at all. 

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Last week’s ISM manufacturing survey in the US in effect showed that the supply side of the economy is in a recession. While the US consumer remains resilient for the moment, spending is largely on services rather than goods, and overwhelmingly dependent on credit. 

Looking through the murky data, markets have bought into the notion of a “soft landing” for the economy. This interprets jobs market strength as a sign the economy can muscle through higher interest rates without a recession, arguing that “this time is different” because of structural changes in the US economy. 

Post-Covid, they say, it is possible for inflation to moderate without the usual fallout in the jobs market that would result in higher unemployment and a recession.

Speaking last week, Federal Reserve Chair Jerome Powell echoed these sentiments. Saying that he is still holding out for “substantially more evidence” that inflation is coming down for good, he stopped short of ruling out interest rate cuts. Markets swooned, with liquidity surging into risk assets and the Nasdaq closing up 2%. One:nil to Team Soft Landing.

Meanwhile, the ever-dwindling cohort of naysayers who believe markets have run ahead of themselves – and that a recession remains likely – continue to claim that, with persistent inflation, rates must remain restrictive. 

In this interpretation, labour market resilience just prolongs the process and will make the eventual crunch even more painful. Claiming that it is too soon to be declaring victory in early February, their base case continues to be employment lay-offs around midyear and a US recession in the second half of 2023.

They argue that it is possible the Goldilocks narrative (i.e. slowing wage growth and low unemployment) remains alive and kicking for several more months, but it is unlikely to persist past the northern summer. 

Some bad news on inflation midyear – showing that the hot economy is preventing price levels from moderating – could force the market to move its estimate for the peak policy rate up and extend its expectations for how long high rates will last. 

This could lead to a very large, very fast repricing in markets.

The chance of a soft landing comes down to how quickly inflation moderates and, on this, no one really has any idea what will happen. 

We continue to live in the throes of the post-Covid monetary and fiscal experiment so, in that sense, this time really is different. 

In the meantime, there is no doubt liquidity has decided not to fight the Fed and is buying the assumption of a return to growth before any good news itself. And why not? 

After a bleak 2022, for the moment it may well pay investors to enjoy themselves and go along for the ride. BM/DM