What's behind the stock market's sudden reversal?

The stock market has taken a turn for the 2023 year.

Many people expected that stock prices would fall during the first half of the year, as the Federal Reserve continued to raise interest rates. They thought that prices would start to recover after the middle of the year, when the Fed stopped increasing rates.

But stocks have surged in January, with the S&P 500 index up 6% after a 2.5% rise this past week. The Nasdaq Composite has risen 11% so far in 2023, following a 4.3% increase in the past five sessions. The S&P 500 rose above its 200-day moving average, an impressive technical indicator. The index has regularly advanced in intraday trading, including every session this past week, another bullish sign.

This year's rally has been led by some of the sectors that were hardest hit in 2022, including technology, banks, entertainment, and commodities. Defensive groups that held up well in 2022 when the S&P 500 declined by over 20% are down by about 2% so far this year.

The most speculative stocks are leading the way for winning groups. Warner Bros. Discovery (ticker: WBD), a media company with a lot of debt, is the top stock in the S&P 500 this year. It's up 57% after falling 63% in 2022. Warner Bros. Discovery had a tough 2022, but there are reasons for hope in 2023, according to Macquarie analyst Tim Nollen.

Macquarie analyst Tim Nollen sees reasons for hope for the film and TV giant in 2023, despite a 60% stock decline last year. Nollen cites the company's strong slate of upcoming releases and its recent partnership with streaming giant as positive indicators for the future.

Tesla (TSLA) is the second-largest company in the index, up 44% to $178. This past week, CEO Elon Musk offered bullish comments on the company's earnings for the fourth quarter of 2022. Tesla's stock price has surged in response, but it still has a long way to go to get back to where it started the year.

The electric-vehicles company posted better-than-expected net income for the fourth quarter of 2022. This has led analysts and investors to speculate about what the company will achieve in 2023.

Tom Lee of Fundstrat is one of the most bullish strategists coming into 2023. He believes that inflation peaked in mid-2022 and that the Fed will need to take action this year to correct the situation. This, in turn, could lead to a 20% gain in the stock market in 2023.

"The data we've seen in the past few weeks supports our view that equities are far more resilient than the consensus narrative," he wrote on Friday. The consumer price index, for instance, has risen at just a 2% rate in the past six months.

The Fed is widely expected to boost the key federal-funds rate by a quarter percentage point this coming week to a range of 4.5%-4.75%. This would be the third interest-rate hike in just over six months and would put the Fed on track to continue tightening monetary policy into 2018.

According to fed-funds futures, there is only a 6.8% chance of a half-point interest rate increase.

The bond market is expecting the Fed to begin easing soon, though the pace of the easing is still up for debate. The bond market is discounting one rate cut later this year, and many more in 2024 that would take short-term rates down to 3%. Stock investors, on the other hand, think the Fed will move more quickly on easing.

"Valuation is not a headwind," says Hank Smith, head of investment strategy at Haverford Trust. "The S&P 500 is not excessively priced at 18 times forward earnings with inflation coming down."

According to Smith, there are several bullish factors that could lead to higher than expected profits this year. These include a weaker dollar, the reopening in China, lean inventories, and cost-cutting moves.

It's rare to see back-to-back yearly declines in the S&P 500. It has happened just twice since the end of World War II, in 1973-74 and for three years from 2000 through 2002.

Treasury inflation-linked savings bonds may have lower yields in the future due to lower inflation rates in recent months.

The rate on Treasury series I bonds is reset every six months, and the new rate in May is expected to be lower than the current 6.89%. The May reset will be based on the change in the consumer price index from September 2022 to March 2023.

So far, the data for the past three months has shown no change in the index. If we assume that the index will increase by 0.3 percentage points each month from January to March, then the new rate in May is likely to be around 2%.

Investors rushed to the Treasury’s website in October to get a 9.6% rate, which had been in place for six months before the current rate was set in early November. October issuance totaled almost $7 billion, a monthly record, but then fell to about $1 billion in both November and December.

I bonds have some advantages, even with a lower interest rate. They offer investors protection against inflation, and come with tax benefits. Investors can defer paying taxes on the interest income until maturity in 30 years, giving them an IRA-like quality. Interest is exempt from state and local taxes but subject to federal income taxes.

The downside is that people can only purchase $10,000 worth of bonds per year.