‘FOMO’ Stock Market rally stalled out. The question is what will decide its fate.

This past week, investors began to accept what the Federal Reserve has been saying, which halted a ferocious tech-led stock market rise.

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Bulls, on the other hand, see the potential for equities to continue to increase as institutional investors and hedge funds play catch-up after selling or shorting stocks during last year's tech crash. Bears argue that a still-scorching labor market and other reasons will push interest rates considerably higher than investors and the Fed to anticipate, reiterating the market dynamics of 2022.

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According to the Federal Reserve, the Fed Funds Rate will peak at 5% and will not be reduced until 2023. As of Friday, Fed funds futures implied a peak rate of over 5.17% and a year-end rate of 4.89%, according to Bank of the West's senior economist, Scott Anderson.

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After Fed Chair Powell's press conference on February 1, the market continued to anticipate the fed-funds rate to peak at 4.9% and close the year at 4.2%. In conjunction with a rise in the Institute for Supply Management's services index, the January jobs data issued on February 3 helped to turn the tide.

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Since the Fed meeting, the yield on the policy-sensitive 2-year Treasury note TMUBMUSD02Y has increased by 39 basis points to 4.510%.

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"These big interest rate movements at the short end of the yield curve are a large step in towards the right direction, the market has begun to listen, but rates still have a long way to go to reflect present conditions," noted Anderson. "A Fed rate decrease in 2023 is still a long shot, and January's good economic numbers make it much less likely."

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The rise in short-term rates appeared to unnerve stock market investors, as the S&P 500 SPX, +0.22%, saw its worst weekly performance since 2023, and the Nasdaq Composite COMP, -0.62%, ended its string of five consecutive weekly advances.

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Despite this, equities are still advancing well in 2023. Bulls are increasing in number, but not to the point where they represent a threat, according to experts.

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The previously down tech-related equities have come back to life at the start of 2023, mirroring 2022's market collapse. The tech-heavy Nasdaq Composite is about 12% higher in the new year than the S&P 500, which is 6.5% higher. The Dow Jones Industrial Average DJIA, +0.50%, outpaced its rivals in 2022 and is the laggard this year, increasing by only 2.2%.

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Who, then, is buying? In a phone interview, Mark Hackett, Nationwide's chief of investment research, stated that individual investors had been relatively aggressive buyers since last summer, prior to the stocks' October lows, while options activity has skewed more toward buying calls, as traders bet on a market rise, rather than playing defense by purchasing puts.

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Analysts report that institutional investors entered the new year underweight equities relative to their benchmarks, notably in the technology and related sectors. This has generated an element of "FOMO," or fear of missing out, compelling people to catch up and boosting the rally. Hedge firms have been compelled to close short positions, contributing to the advances.

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"The critical question for the next market move, in my opinion, is whether institutions will destroy consumer sentiment before consumer sentiment destroys institutional bearishness," Hackett said. "And my guess is that the institutions will look and say, 'Hey, I'm several hundred basis points behind my benchmark right now. I must catch up because being short in this market is simply too unpleasant."

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However, the last week held some unwanted echoes of 2022. The Nasdaq led the decline as Treasury rates increased. The yield on 2-year notes TMUBMUSD02Y, most sensitive to Fed policy forecasts, reached its highest level since November.

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There were indications that options traders were hedging against the prospect of a near-term increase in market volatility.

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