The economy and the stock market: two different beasts

• January's U.S. CPI report shook the markets, impacting stocks, bonds and the U.S. dollar as it changed expectations for the Fed's policy.
• A typo in Lyft's earnings briefly sent its stock up 60%, showing how automated trading can react dramatically to mistakes.
• Despite Japan entering a recession, the Nikkei Index remained strong, highlighting that stock markets can thrive even when the economy doesn't.

This week in the financial world was a bit of a rollercoaster, starting off with a bang as the latest U.S. Consumer Price Index (CPI) report for January sent shockwaves through the markets. The report was hotter than many had expected, leading to a drastic change in expectations for Federal Reserve (the Fed) policy. As a result, stocks and bonds took a hit, and the U.S. dollar's value shot up. The small-cap stocks in the Russell 2000 felt the brunt of the selling pressure, mainly because many of these companies need lower interest rates to affordably refinance their debt. Even the larger indices like the NASDAQ and S&P 500 weren't spared, though they did manage to recover some of their losses by the end of the day.

The reaction in the money markets was swift, with the probability of a March rate cut by the Fed plummeting, and expectations for the rest of the year also being scaled back significantly. In an interesting twist, Fed Chair Powell mentioned in a meeting with the U.S. Congress that the CPI data aligned with their forecasts, hinting that the upcoming Personal Consumption Expenditures (PCE) report would be the next piece of the puzzle. This calming statement, along with a tech-driven rally, helped U.S. equity futures to bounce back, somewhat soothing the initial panic.

Then came the retail sales report for January, which showed a decline of 0.8%, contrasting sharply with the December numbers that were widely above expectations. This wasn't entirely unexpected, considering the surge in spending during the holiday season, but it certainly didn't help the mood. January was payback time, not spending time.

A bizarre incident with Lyft's stock provided a bit of comic relief amidst the market's turmoil. After reporting its fourth-quarter results, which were decent but not spectacular, the stock inexplicably soared 60% and added billions in value in after-hours trading, only to crash back down when a typo in its earnings document was discovered. This typo massively overestimated the company's profit margin projections for the next year. The actual number was 0.5% but written on the statement was 5%. Any human would have spotted and ignored the typo, but alas, humans are a relic in the financial world. It shows that automated trading systems can sometimes get things spectacularly wrong.

Lastly, a glance at Japan offered a stark reminder that the stock market and the economy don't always move in lockstep. Despite the Japanese economy entering a recession, the Nikkei Index has been performing remarkably well, nearing its all-time highs set back in 1989. This decoupling serves as a fascinating example of how markets can remain strong even amid economic downturns, further complicating the dance between economic indicators, central bank policies and market dynamics. A recession does not automatically mean your portfolio will crash down: that is the main takeaway here.

Listen to this week’s podcast for further insights.