Remember that feeling when your parents told you about a big upcoming vacation? Is the growing excitement of anticipation keeping you up at night?
That’s how the market has felt since it learned that the Federal Reserve will cut interest rates at some point in 2024. However, it’s been nearly four months since the central bank hinted that it would start lowering its rate of reference, and no final decision. the dates have been announced.
That’s not stifling investor optimism, however, as tepid speculation surrounded this week’s Fed policy meeting, despite Chairman Jerome Powell’s caution over the timing of the Fed’s rate cut this year. And with inflation stalling and the economy booming so far in 2024, this meeting failed to provide any clarity on exactly when the interest rate cuts will occur.
But despite this, investors seem to expect the stock market to continue rising for the foreseeable future, with their bullish bias evident across a number of market trends.
3 ways investors are showing optimism
In 2023, the Fed was praised for its rate hike cycle, which proved exceptionally effective in containing runaway inflation. That year alone, such increases were able to reduce inflation by as much as three percentage points. But hesitation to cut rates has grown in recent months, with inflation essentially stagnant and well above the Fed’s target rate of 2%.
Expectations for this year included up to three rate cuts, but that plan was never set in stone and continues to be complicated by sticky inflation. Further complicating the situation is that cutting rates too soon could allow inflation to rise, but keeping rates higher could result in a hard landing and subsequent recession. The March meeting demonstrated how delicate the Fed’s balancing act is, and since the next meeting isn’t until April 30-May 1, there will be no immediate policy changes.
This shouldn’t be a surprise, however, given the evolution of inflation data, as measured by the consumer price index, but investors appear to be playing the market as if its 2024 rally is set to continue. This is how we know that investors are optimistic, which is simultaneously a cheat sheet for investing if you are also an optimist.
1. Investors are putting more money into equity funds
Equity funds are mutual funds invested in stocks. They are a common way for investors to get exposure to multiple stocks without having to worry about managing all the individual investments themselves. Some funds are actively managed, with portfolio managers constantly evaluating holdings and adjusting them based on performance. Others are passively managed, such as index funds, with holdings adjusted only to reflect changes in an underlying benchmark.
Over the past month, the amount of money investors have pumped into equity funds has continued to increase. In mid-March, equity funds saw a single-week increase in inflows of nearly $5 billion, the third straight week that more money flowed into such funds than out of them.
This influx of money into stocks comes as index funds posted spectacular growth earlier in the year. The S&P 500, for example, has surpassed its all-time high several times in early 2024, as have other indexes such as the Dow Jones Industrial Average and Nasdaq. These records, combined with slowing inflation reduction, might lead investors to believe that they will take profits, but instead they are doubling down.
2. Options traders load calls, but not puts
Options trading does not involve purchasing a security and subsequently selling it; instead, it is a contract between a buyer and a seller based on the price of the underlying security. There are two types of options: calls and puts. A call option gives the investor the right to buy a stock at a predetermined “strike” price once the stock reaches that price, while a put option gives the buyer the right to sell a stock at a predetermined strike price when the stock reaches that price.
Put options are a common way for investors to protect themselves from volatility; if an investor owns a stock, he can purchase put options that allow him to sell at a guaranteed price, adding peace of mind to the portfolio. In essence, put options are bearish bets that allow traders to make money from the decline in the price of the underlying stock. On the other hand, call options are bullish bets that allow traders to make money from rising prices of an underlying security.
Experts can use something called “skew” to gauge investor sentiment with options trading. During periods of market rallies like this year’s, experts expect higher negative skew, meaning investors buy more put options in anticipation of price declines resulting from a broad market pullback. However, what they are finding instead is a “flat skew,” meaning investors are buying fewer put options to hedge their bets. In fact, the data suggests that fewer investors expect the market to pull back any time soon.
3. IPO hype continues to persist
Investing in an initial public offering, or IPO, is not something you would do during a time of market turmoil. While IPOs offer the chance to invest in a company on the ground floor, new-to-market stocks experience a lot of growing pains and volatility as investors sell off the news and the shares get priced out. Furthermore, research shows that IPO stocks are often unprofitable across the board.
So, with concerns that the Fed will remove rate cuts and send the market lower, you’d imagine that social media company Reddit’s IPO this week wouldn’t be as sought after as it seems. But the numbers say otherwise; Reddit IPO is five times oversubscribed.
What does it mean? While any investor can purchase a stock as soon as it enters the market for public trading, to actually access the IPO shares at the determined asking price requires the individual investor to apply, or sign up, to invest in the company in advance.
Before listing on Reddit, there are five times more subscribers than shares available for purchase. What this shows is that not only are investors comfortable investing in an IPO, but they are also willing to invest in a social media company that for much of its existence has been unprofitable – not behaviors typically associated with potential market volatility on the horizon.
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