The Future of the Stock Market Rally

The stock market has experienced an impressive bull run, but investors are uncertain about what will propel it even higher.

Rise of Riskier Assets

In 2023, the market rally has been largely driven by the resurgence of riskier assets that were heavily impacted during the bear market of 2022. This is evident in the soaring performance of Big Tech, with the Nasdaq Composite surging by over 33% since the beginning of the year, almost double the S&P 500's gain. Additionally, the Technology Select Sector SPDR Fund (XLK) has seen a 40% increase, and Bitcoin has skyrocketed by 76%.

Skepticism Amidst Sentiment Reversal

While some investors remain skeptical after the recent sentiment reversal, they have been awaiting a significant correction in speculative assets to no avail. Part of the reason for this is the strong economic data that has boosted confidence in the market's outlook.

Where is the Next Rally Coming From?

However, Big Tech and other market leaders have already reaped substantial gains from the optimism surrounding 2023. Moreover, the ripple effects of the rapid increase in interest rates over the past year or so may not have fully manifested. Real interest rates, which take into account inflation, have only recently turned positive, making borrowing costs even more burdensome.

This raises the question of what will drive the next phase of the rally. In a research note, Capital Economics senior markets economist Thomas Mathews deliberated on this topic. Many other market watchers are also pondering the same question.

Mathews believes that the market's gains are not excessive given the resilient state of the economy. However, certain second-quarter corporate profits and outlooks have failed to meet expectations, as evidenced by the decline in shares of Apple (AAPL) and Microsoft (MSFT) following their reports.

The Impact of Earnings Season

With an uneven earnings season unfolding, there is one less factor that could serve as a catalyst for pushing stocks higher. Just a month ago, market strategists emphasized the importance of Big Tech earnings in sustaining the rally.

Overall, while the stock market rally has been remarkable, the path to future gains remains uncertain. As investors navigate this landscape, they will keep a watchful eye on various factors that could shape the market's trajectory.

The Markets Await News for a Shift

In the absence of market-catalyzing news and after a strong run, the markets may remain listless for the next month, according to Jason Draho, head of asset allocation for the Americas at UBS Global Wealth Management. A notable change in market narrative will likely require the release of August data and the September Federal Open Market Committee meeting.

August Returns and Market Struggles

Historically, August hasn't been known for its significant returns, leading Tom Lee of Fundstrat to suggest that markets could struggle for traction this month.

Uncertain Rally

While there is currently no apparent reason to stop the rally, there also isn't a clear catalyst for it to continue delivering substantial returns. According to Matthews, a factor that could potentially boost equity valuations is enthusiasm about new technologies like AI or superconductors.

Hope for AI and Innovation

There is a growing belief among some that the market needs hope in the form of AI or similar innovations to keep soaring. Sevens Reports' founder Tom Essaye points out that at current levels, the S&P 500 has already priced in certain expectations. These include no hard landing, falling inflation, and a Federal Reserve that won't be raising rates much longer, possibly even cutting rates soon.

In conclusion, stocks have seen legitimate gains driven by favorable outcomes. However, the near-term potential for significant gains is likely exhausted. It will require something else to push stocks higher from this point onwards.