U.S. stocks staged a stunning turnaround this past week, posting their biggest gains since 2020 as investors bet the Federal Reserve will downshift the pace of rate hikes soon.

The Dow Jones Industrial Average soared 5.3%, the S&P 500 spiked 5.9%, and the Nasdaq Composite skyrocketed 8.1% in a broad rally. The major indexes logged their best weekly performance since November 2020.

Growing hopes of a Fed pivot fueled the powerful rebound after September’s consumer price report showed inflation cooling. Bets are rising that moderating price pressures will let the Fed ease up on its aggressive rate hike campaign.

The benchmark 10-year Treasury yield plunged from 4.2% to 3.7% in the span of a week, its biggest drop since 2020. Falling yields boosted pricey growth stocks, especially battered tech names. The Nasdaq had its best week since March.

All eyes now turn to the October CPI data and the Fed’s December policy meeting. Markets are pricing in a 50-basis point rate hike next month, down from the 75 bp jumbo hikes at the past four meetings.

The Fed still has more work to do curbing demand and reining in inflation. But Chair Jerome Powell signaled the central bank is ready to downshift soon, buoying investor sentiment.

“The Fed has finally acknowledged the need to balance countering inflation with financial stability,” said Nationwide’s Mark Hackett. “Risk assets rallied as recession fears ease and markets anticipate a policy pivot.”

Oversold Bounce or Sustained Rebound?

Some experts caution the exhilarating rally may be overdone. The S&P 500 rebounded 5.9% in just one week after plunging over 25% this year. Such rapid reversals often signal bear market rallies.

Indexes also face resistance near their 50-day moving averages after closing below those levels for weeks. Holding these gains would show renewed strength. But a retreat back to recent lows would not come as a shock.

“It’s premature to declare the bear market over when the Fed is still early in the hiking cycle,” warned CIO Doug Cohen of AthenaInvest. “We expect continued volatility until inflation is unquestionably tamed.”

Others contend conditions are falling into place for a more sustained rebound. Valuations have become much more attractive after this year’s brutal selloff. Earnings have proven resilient aside from tech and consumer discretionary. The economy is slowing but not collapsing.

“We are in the later stages of this bear market,” said Keith Lerner, co-CIO at Truist Advisory Services. “Economic and market extremes typically set the stage for the next bull run.”

Rising Participation Fuels Rally

Renewed breadth has underpinned the rally, a key technical indicator. Small caps, transports, industrials, materials, and financials have rebounded after badly lagging for months.

The small-cap Russell 2000 soared 10.9% last week, its best since 2020. The index remains 30% off its 2021 peak but has bounced sharply above its September low.

Bank stocks surged on rising rate expectations. The SPDR S&P Regional Banking ETF (KRE) leapt 16.3% to exit a bear market. Financials gained as Treasury yields rebounded off their lows.

“We’re seeing broad-based buying rather than just a handful of megacap tech stocks lifting markets,” said Ryan Detrick, chief market strategist at Carson Group. “Widespread participation signals conviction in the rally.”

The market upturn regained positive momentum this past week. The number of S&P 500 stocks trading above their 50-day lines soared to 85%. New 52-week highs finally outpaced new lows after weeks of woeful breadth readings.

Rotation Back Into Growth

While value and cyclical sectors participated, growth stocks again took the lead. Megacap technology and e-commerce names extended their recent resilience.

Nvidia (NVDA) rebounded 15% after positive earnings news from fellow chipmaker Micron. Shares reclaimed the key 200-day moving average. Nvidia has been consolidating for four months after tumbling from record highs.

The ARK Innovation ETF (ARKK) soared 20%, buoyed by top holdings Tesla, Roku, Zoom Video and Shopify. High-multiple tech stocks tend to benefit most from falling bond yields.

Amazon (AMZN) vaulted 12% after its stock split took effect, making shares more accessible to retail investors. But the e-commerce titan remains deep in a bear market, 50% off its peak.

Apple (AAPL) bucked the rally, sliding 1.4% after trimmer iPhone sales indicated demand headwinds. Supply shortages have eased ahead of the critical holiday season.

Search leader Alphabet (GOOGL) only managed a 0.8% gain despite blowout earnings. But it broke a five-week losing streak, finding support at its 200-day average.

New Opportunities Emerge

With the major indexes off their lows, more leading stocks are emerging from bases or flashing early buy signals:

• Chipotle Mexican Grill (CMG) surged 15%, clearing a 1,256.85 buy point from a nine-week consolidation ahead of earnings.
• Tesla (TSLA) rebounded 7% from recent lows but remains below its 50-day line as deliveries slow. An aggressive investor could treat its 200-day line reclaim as an early entry.
• Costco (COST) is extended after a 13% weekly gain but its resilient earnings growth makes it a long-term hold.
• Dollar General (DG) rallied 6.6% and reclaimed its 50-day average. The discount retailer is building the right side of a base.
• Zscaler (ZS) broke out of a flat base on heavy volume Friday. The cybersecurity play has held up well amid tech’s correction.
• HubSpot (HUBS) flashed an aggressive entry Friday above its 10-week line as it vies to break out of a base.

What Should Investors Do Now?

The whipsawing markets have tested investor resolve this year. The recent recovery rally has lifted spirits but questions remain.

Now is not the time to go “all in” on speculative names. But it makes sense to gradually add exposure in high-quality stocks breaking out with sound fundamentals and institutional support.

Focus on pockets of market strength. The energy, healthcare, discount retail, defense and cybersecurity sectors are prime hunting grounds.

Review your holdings and cull laggards showing poor sales and earnings growth. Reinvest capital from trimming losers into market leaders with superior fundamentals and price action.

Keep a defensive tilt, holding cash to weather the next pullback. Limit purchases to a small percentage of your capital until the major indexes decisively reclaim their 200-day averages.

Stick to discipline and patience in these volatile markets. The bottoming and recovery process takes time. Control risk through prudent position sizing, diversification, and sell rules.

With Treasury yields falling, the backdrop for equities looks more constructive. But risks remain until the Fed clearly eases its hawkish stance. Tread carefully and stay nimble to maneuver through the challenging months ahead.