There are Reasons to be Optimistic about the Stock Market

Currently, the stock market just can't seem to drop any more-at least not as much as it used to. Wall Street doesn't seem to be concerned about another Fed interest-rate hike or the turmoil in the banks, regardless of what's happening in Washington.

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This stubbornness could be attributed to a number of good reasons.

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I would like to begin by reviewing the resilience of the market first. One of the most recent and clear examples of this is the panic that has gripped the banking industry. Taking into account the problems of Silicon Valley, Signature Bank, and Silvergate - 11,41% banks, as well as the wobbly First Republic Bank, all of these troubles threaten the already slowing economy that is already hard to recover from.

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As a result of depositors withdrawing billions from their bank accounts, and tucking their dollars into higher-yield money market funds, SVB SIVBQ +2.79% and First Republic (ticker: FRC) were among several smaller banks in the process. If the banks were to lose their cash, this could have a negative impact on the economy and force them to sell assets at a loss in order to maintain liquidity in the market. 

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Adding to the drama unfolding, we must not forget about the Fed's meeting in March, during which members decided to raise interest rates by another quarter-point, after a year in which rates had risen mostly by half-points and by three-quarters of a point. There is no doubt that the higher interest rates are intended to put more pressure on the economy, lowering the inflation rate by pushing down the demand.

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However, so far this year, the market has held up well. Following an initial drop, the S&P 500 now stands a touch higher than it did pre-SVB in early March. 

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Why is that so? 

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For starters, let us take a look at the banking troubles, which don't seem likely to stir up the economy anytime soon-at least not at this point.

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Last week, billions of dollars were withdrawn from those high-yield money-market funds and the Fed eased up on its borrowing from the banks after the collapse of SVB, which had hit a record level right after the collapse of that fund. According to Bank of America BAC -0.72%, outflows from the money markets and the drop in borrowing indicate that money may be relocating to bank deposits as a result of the outflows from the money market.

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Next, you should add the sale of SVB's assets to First Citizen, which was completed last year. There has been a restoration of some confidence in the financial system as a result of the deal.  

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As a result, the Fed decided to raise rates by just a quarter-point due to the banking mess playing no small part in their decision. As a result, many economists were predicting a mild recession rather than a deeper recession as a result of a larger bump in interest rates, and the central bank was concerned about that happening. There is even talk now of a true Fed pause, which would mean a stopping of interest rate increases for a period of time.

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There is a drop in the yield for the ten-year Treasury note, from just over 4% to about 3.55% today. Eventually, when long-term Treasury yields decline, the value of future profits will rise - and stocks will become more attractive to investors. It works in the following way: When the long-dated yields fall by a significant amount, the actual value of future profits is significantly boosted, as the longer-dated yields drag the corporate bond yields down with them. In general, according to Wells Fargo WFC –0.74%, the long-dated investment-grade corporate bonds have fallen from just over 5% a few weeks ago to just under 5% today, from just over 5% just a couple of weeks ago.

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A combination of the yields on safe government bonds and the yields on the bonds that the company issues are used to discount the future earnings of the company. Alternatively, you might want to look at it this way: Analysts have aggregated earnings estimates for the next year for S&P 500, relative to its current level, yield just under 6%, which is still higher than investment grade bonds, but lower than the S&P 500 low yields. As a result, there is a trend in the stock market that is encouraging more risk-taking as yields are falling across the board. 

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As a result of lower yields and a view that a tightening cycle has started in the U.S., Chris Harvey, Wells Fargo's chief U.S. equity strategist, believes that stock prices should remain higher for the time being. 

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Now, the big question is: Will the economy crack and send stock prices down?

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There is a trend for higher interest rates to dent demand in a delay because yields are still far higher than where they were just a few years ago. Although the banking jitters have subsided for the time being, the economy is still susceptible to a bit of a slowdown. As a result of a slump, corporate earnings could be hurt, and the stock market could take a hit. 

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There are many reasons why the market is strong right now, so go ahead and be optimistic about the upcoming year. Don't be surprised if there are some bumps along the way.