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Why Stocks Are Rallying in the Midst of a War and Soaring Inflation

Tesla’s recent performance has made its stock particularly popular.
Photo: josh edelson/Agence France-Presse/Getty Images

Investors are confronting one of the most uncertain periods of their lifetimes. Stocks are rallying anyway. 

The S&P 500 has rebounded 7.6% from its 2022 low on March 8, cutting its losses for the year to about 6%—roughly half of what they were weeks ago. In many ways, investors say, the rebound has been as broad as it has been impressive, lifting everything from travel stocks to utilities to unprofitable technology companies.

A…

Investors are confronting one of the most uncertain periods of their lifetimes. Stocks are rallying anyway. 

The S&P 500 has rebounded 7.6% from its 2022 low on March 8, cutting its losses for the year to about 6%—roughly half of what they were weeks ago. In many ways, investors say, the rebound has been as broad as it has been impressive, lifting everything from travel stocks to utilities to unprofitable technology companies.

A month ago, Russia’s war in Ukraine was intensifying, sending oil prices surging to $130 a barrel and stocks sharply lower. Covid-19 cases began surging again in China. Inflation data showed that pricing pressures weren’t abating. And in the midst of all of it, the Federal Reserve kicked off a rate-hiking cycle for the first time since 2018. 

Fed Chairman Jerome Powell discussing the Federal Open Market Committee decision to raise interest rates.
Photo: Michael Nagle/Bloomberg News

Not much has changed, except stocks are now back on the upswing. Many investors are trying to discern whether the rebound is the start of a sustainable rally or merely a temporary respite. The broad stock market index pulled back 1.3% last week, snapping a three-week winning streak that marked its best performance since November 2020.  

Here are six reasons for the rebound. 

1. History Suggests Stocks Have More Room to Run

The anticipation of the Fed’s March rate increase stirred volatility for months as investors braced for the unwinding of stimulus that helped turbocharge stocks. But history shows that stocks typically rise after the central bank starts raising interest rates. 

In the five rate-hiking cycles since 1990, the S&P 500 tumbled a month after the first rate increase but typically recouped those gains to rally six months later. After one year, the S&P 500 and Nasdaq Composite were up 80% of the time, according to Dow Jones Market Data. 

“The early stages of Fed tightening should not be seen as a negative for stocks, as equities tended to make new highs after the initial volatility,” a team of
JPMorgan Chase & Co.
strategists led by Marko Kolanovic wrote in a note to clients Monday.

Still, recession fears are growing.
Deutsche Bank’s
chief U.S. economist warned about a recession this year, fueled by aggressive tightening from the Fed.

Jeremy Grantham,

co-founder of Boston money manager GMO LLC, said Wednesday that oil price spikes like the one this year “have always preceded or triggered recession.” 

Yet some investors aren’t willing to cash out of the market to time a downturn. 

“The market can go up a lot before you get to the recession,” said

Mark Stoeckle,
chief executive of investment firm Adams Funds. “That’s a lot of risk that you’re taking on if you’re going to begin to reposition your portfolio for an impending recession.” 

Mr. Stoeckle said that, so far, the economic data he has seen doesn’t point to a recession in the near future. 

To be sure, rate-hiking cycles don’t always end well for stocks. According to Deutsche Bank analysts, eight of the 11 cycles over the past seven decades have resulted in recessions.

Take, for example, when the Fed began raising rates in the 1970s and the late 1990s. In both cases, major U.S. indexes largely finished the cycles with losses and, soon after, the economy tipped into a recession. 

2. The Economy Is Still Strong

Consumers have been sending mixed signals on how they feel about the economy. Economic data suggest things aren’t as bad as many fear. 

U.S. job growth remains strong, with the March report showing employers added 431,000 jobs, the 11th straight month with an increase of more than 400,000. That marked the longest streak in records dating back to 1939. 

Investors point to other encouraging signs: Wages continue to grow. In March, average hourly earnings for employees on private nonfarm payrolls rose 5.6% from a year before, Labor Department data show. 

Meanwhile, American finances look healthy, which could help buoy the economy as inflation flares. Brian Rose, senior U.S. economist at UBS Global Wealth Management, estimates that consumers accumulated excess savings of about $2.5 trillion during the pandemic. 

A restaurant in Schaumburg, Ill., advertised for workers this month.
Photo: Nam Y. Huh/Associated Press

Still, some cracks are starting to emerge: U.S. consumer spending in February slowed sharply from the month before, as inflation—which jumped to an annual 7.9% rate in February—weighed on households and chipped away at wage gains.

3. Real Yields Are Still Negative

Many investors say stocks are still being lifted by one closely watched bond-market metric: real yields.

Real yields are what investors receive on U.S. government bonds after accounting for inflation. Despite the sharp rise in Treasury yields this year, so-called real interest rates are still quite low. For now, investors say, that is providing support for the economy and an incentive for investors to seek returns in riskier assets.

The yield on five-year Treasury inflation-protected securities—a benchmark gauge of real interest rates over the next half-decade—stood Friday at about minus 0.6%, according to Tradeweb. That was up from about minus 1.6% at the end of last year but still well below the 1% level it reached in 2018.

4. Individual Investors Buy the Dip 

Individual investors have helped drive the recent surge in meme stocks and shares of unprofitable technology companies, data from Vanda Research show. 

Last month, individual investors piled into shares of the ARK Innovation exchange-traded fund, purchasing a net $132 million in shares, the second-highest monthly total on record and nearly three times the monthly 2021 average, according to Vanda data. The fund, which is run by

Cathie Wood
and trades under the ticker ARKK, is heavily invested in buzzy companies, some of which struggle to turn a profit.

Meanwhile, demand for bullish call options that are “out-of-the-money,” or far from currently paying out, recently hit the highest level since early 2021, Vanda estimates. Bets on meme stocks and tech shares such as
Nvidia Corp.
, Twitter Inc.,
Tesla Inc.
and
Advanced Micro Devices Inc.
are particularly popular. 

Goldman analysts said in a note to clients in late March that a bump in retail-trading activity helps explain the gains in stocks like nonprofitable technology companies that are typically sensitive to interest-rate increases.

“Sentiment from the most speculative part of the retail community is becoming increasingly optimistic,” Vanda analysts wrote in an April research note. 

The activity is in contrast to much of the quarter, when trading by the group subsided. Estimates from Bloomberg Intelligence show that individual investors accounted for about 17% of U.S. stock-trading activity in the first quarter, the lowest level since 2019, before the pandemic triggered a rush of activity. 

5. Bets on Corporate Resiliency

First-quarter earnings season will kick off in earnest this week, and many investors expect another period of strong results.

Earnings among companies in the S&P 500 are expected to have increased 4.5% from the year before. Although that result would pale in comparison with the blockbuster growth of recent periods, it is generally in line with the median growth rate since the first quarter of 2012. 

Analysts point to one particular bright spot: Many think U.S. companies will be able to navigate soaring inflation by raising prices. The estimated net profit margin for S&P 500 companies is 12.1% for the first quarter, higher than the five-year average of 11.2%,
FactSet
data show.

“At the moment, there is this relative sweet spot for equities, whereby they feel comfortable with rising inflation—they think that U.S. companies retain pricing power and that it won’t result in margin compression,” said Huw Roberts, head of analytics at Quant Insight. 

6. A Technicals Snapback

There are technical factors driving the rebound, too. Many institutional investors appear to have aggressively dumped stocks to start the year, traders and analysts said.

“During the invasion…it felt like [the selloff] was all driven by de-risking,” said Glenn Koh, head of global equities trading at
Bank of America.

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How optimistic are you feeling about the stock market? Join the conversation below.

For example, Bank of America analysts estimate that bearish stock positions among commodity trading advisers,  computer-driven funds that try to make money betting on market trends and patterns, surged in March before pulling back on those bets. Recently, Mr. Koh said, some investors might have had to unwind bearish positions, helping drive a rally. 

“It felt like it was more short covering,” Mr. Koh said.  

—Sam Goldfarb contributed to this article.

Write to Gunjan Banerji at gunjan.banerji@wsj.com and Caitlin McCabe at caitlin.mccabe@wsj.com

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