Equity markets are undoubtedly in a bullish mood, with positive market sentiment and a broadening out of the rally in stock prices in recent weeks.

What was a narrow rally in stocks during the first half of 2023, with a small number of large technology names dragging stock indexes up, has widened to include many other index constituents across different sectors of the economy.

Better than expected economic data releases and lower than expected inflation prints have supported this broadening out of the stock rally.  Measures of positive / negative surprises on economic data are at their highest level in two years, indicating consistent beats on expectations.  This has historically been a positive lead indicator for short-term stock returns.

The stock rally coincides with investor sentiment hitting the highest levels since 2021.  This is an increasingly popular rally with wider participation from retail and institutional investors alike. 

Higher asset prices have two important short-term effects on the economy that we should consider. 

First, it makes those consumers who own stocks feel more confident.  The asset side of their balance sheets is going up and so they feel more confident to spend a greater portion of their disposable income and save less. This extra spending hits the economy quickly.  We are already seeing this effect in consumer sentiment data from the US, with some measures hitting two-year highs.

Second, it acts as an effective loosening of financial conditions.  Much like a central bank cutting interest rates has a lagged effect on boosting the economy via a lower cost of debt, a rising equity market has a similar effect of acting to make equity financing easier and cheaper for companies.  Easier access to capital, whether sourced via debt or equity issuance, is stimulative to the economy. 

In both cases, the above factors are inflationary. This is something investors and market participants should be mindful of in the coming months. 

In the meantime, however, disinflation and bullish market sentiment are clearly the order of the day, and investors should consider tactical participation in this rally while it lasts.   

At time of writing Netflix and Tesla had both announced their financial results and both stocks were trading down in the pre-market.  In both cases, the results were actually pretty good, but relatively slight misses to expectations in revenues for Netflix and profit margins for Tesla, pushed share prices of both companies down in after-hours trading. 

This tells us that the market rally may become more discriminatory as it goes on.  Popular stocks trading on very high valuations (like Netflix and Tesla) may be prone to corrections in price on news-flow, even if that news is only slightly worse than expected. 

Valuation remains king, in our view, and should remain the focus of investors navigating this market. 

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