Welcome to my latest video presentation for Mind Over Markets. The article below is a condensed transcript; my video contains additional details and several charts.

U.S. stocks have rallied significantly off their bear market lows in October 2022, regaining most of the losses they incurred between January and October of last year.

Slackening growth in the jobs market and hourly wages is an early sign that interest rate hikes are starting to manifest themselves in the economy. Rate hikes exert a lagging effect.

That said, we’re also seeing signs of recovery that support the narrative of a “soft landing.” Robust consumer confidence and homebuying data derive from what’s still a strong labor market. Investors should be sanguine about the markets in the second half of 2023.

The rally slowed a bit last week but overall, the upward trajectory is intact, with the S&P 500 currently within 6% of its all-time high.

Last week, the Dow Jones Industrial Average gained 2.1%, the S&P 500 gained 0.7%, and the tech-heavy NASDAQ declined 0.6%. The MSCI EAFE fell 0.3%. The benchmark 10-year Treasury yield finished flat at 3.84% and crude oil prices climbed 2.0%. The main U.S. equity indices also closed higher on Monday.

The latest corporate earnings reports are lifting Wall Street’s confidence. For second-quarter 2023, the blended year-over-year earnings decline for the S&P 500 is -9.0%. Yes, that’s a discouraging number.

However, for Q2 2023, with 18% of S&P 500 companies reporting actual results, 75% of companies have reported a positive earnings surprise and 61% have reported a positive revenue surprise, according to the research firm FactSet.

Many of these earnings surprises have been posted by economic bellwethers, notably the Big Banks. Companies have done a generally good job at navigating the twin perils of inflation and rising rates.

It’s been a positive year for investors so far, but we’re not completely out of the woods yet. The markets are likely to be volatile in coming weeks, until we fully grasp the Federal Reserve’s intentions. What’s more, inflation might convey a nasty surprise in latter 2023.

Last year’s equity sell-off priced in a lot of bad news, e.g. a recession. But it looks like we might avoid a full-fledged recession, which means stocks aren’t likely to revisit the bottom of 2022.

Small caps, as measured by the Russell 2000 Index, also hit their lows last October and they’ve rebounded since then. Small-cap stocks are a key harbinger of the economy’s cyclical path. Smaller companies tend to be more sensitive to the ups and downs of the economy. Their rise year-to-date is an auspicious sign.

While the jobs market remains in solid shape, we’re seeing signs of softness. The three-week moving average in weekly initial jobless claims is up nearly 20% over the last six months.

The Fed has pursued its most hawkish tightening cycle in four decades. Restrictive monetary policy tends to trigger recessions, so investors should be wary of the lagging deleterious impact that rising rates could have on the economy.

The yield curve (i.e., long-term rates minus short-term rates) is heavily inverted. An inverted yield curve occurs when a yield curve graph of bonds inverts and the shorter-term bonds are offering a higher yield than the long-term bonds. An inverted yield curve is considered a leading indicator of recession (see my video for explanatory charts).

A normal yield curve is one in which longer maturity bonds have a higher yield compared to shorter-term bonds, because of risks associated with time.

Bond prices and yields move in opposite directions. An inverted yield curve is unusual; it reflects bond investors’ expectations for a decline in longer-term interest rates, typically associated with economic downturns.

And yet, despite these mixed signals, the bull case remains in effect. Maybe it’s excessive to call current economic conditions a “Goldilocks” scenario, but we’re darn close to it.

The week ahead…

Here are the salient economic reports due for release in the coming days. We face a particularly busy week of data:

• S&P flash U.S. manufacturing and services PMI (Monday);
• S&P Case Shiller home price index and consumer confidence (Tuesday);
• New home sales; Federal Open Market Committee (FOMC) meeting decision on rates, followed by the customary press conference by Fed Chair Jerome Powell (Wednesday);
• Initial jobless claims; durable goods orders; U.S. gross domestic product for Q2; pending home sales (Thursday);
• Personal income and spending; personal consumption expenditures price index (PCE); and consumer sentiment (Friday).

The big news, of course, will be the Fed’s announcement on interest rates. Futures markets are predicting a roughly 70% chance of a 0.25% rate increase at the Fed’s July 25-26 meeting.

In the meantime, risks continue to abound, including the Russia-Ukraine war and tensions between the U.S. and China. And if recent signs that inflation is abating are proven wrong, we’ll probably witness selloffs as the Fed gets hawkish again.

Does all this uncertainty have you on edge? The key to mastering risk resides in what my colleague Jim Pearce calls “Mayhem Trades.”

Jim Pearce is chief investment strategist of our premium trading service, Mayhem Trader. Jim has developed an under-the-radar strategy to flip market mayhem into fast payouts. Want to learn more? Click here now.

John Persinos is the editorial director of Investing Daily.

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