Coming into the month of November, there was a high level of investor trepidation surrounding persistent inflation, further Fed tightening, the risk of a widening of the Israel/Hamas war, a possible government shutdown and concerns about market acceptance of burgeoning Treasury auctions to meet deficit spending. The economic calendar was also showing signs of a weakening consumer heading into the most important shopping season of the year, which can move the needle for the economy.
As it turned out, just four weeks later heading into December, the inflation data at the wholesale and consumer levels came in lower than forecast, a continuing resolution was passed by Congress to satisfy the debt ceiling, a temporary truce between Israel and Hamas materialized, the summit between President Biden and China’s Premier was taken as market neutral, some robust earnings from more big-cap tech companies poured in and Black Friday and Cyber Monday posted record sales.
What became crystal clear within the rally during November was that market sentiment pivoted hard, with the softer inflation data and the notion that the Fed’s mission was accomplished triggering an onslaught of fresh buying. The thinking that took hold was not that the Fed was done raising rates, but that the data implied Fed rate cuts would come as early as spring 2024 when measured by the Treasury futures market. The CME FedWatch Tool is now giving a 55% probability of a rate cut in March.
Strong earnings from the tech sector have really stoked investor confidence, to where sentiment is broadening out to support other sectors that have lagged all year. The analyst community is very split as to the economic outlook for early 2024, again, with much depending on the health of the consumer. With bond yields bumping lower, the positive knock-on effect is already being felt in the mortgage market, with applications up four straight weeks.
However, home prices remain elevated, as do costs for professional services like insurance, repairs, medical, education, travel, etc. Seeing wages climb all last year to keep pace with inflation is something that can’t be lowered, and those higher labor costs will invariably be passed along in the form of higher prices for goods and services. For example, auto prices are already being raised to reflect the UAW contract agreement that includes across-the-board wage increases.
To this point, one could argue that inflation might be bottoming out during the current quarter at around a 3.0% annual pace. Getting to the Fed’s 2% target would imply a sharper slowdown than the market is pricing in. So, the old saying “be careful what you wish for” should be heeded. Hedge fund manager Bill Ackman of Pershing Square, who called the bond market to a tee, is forecasting a hard landing in the first quarter of 2024, citing that the consumer will slam on the brakes due to being way too leveraged. So far, the consumer has proved all the naysayers wrong. We’ll see.
Two encouraging developments occurred last week that fueled further optimism for the current rally. Both the Russell 2000 Small Cap Index (RUT) and the S&P Regional Bank Index broke out to the upside. Each index had been unable to clear their respective 200-day moving averages until mid-week, when bond yields took another leg lower, igniting a fierce buying spree of huge volume in both sectors.
The broadening out of the market is like a force of nature when it takes hold, and though everyone and their brother would give their right arm for a 5% pullback to add stock exposure at way more attractive price levels, it’s just materializing with the 10-year Treasury Note yield diving to 4.21% from 5.0% over a five-week period. The yield curve is once again inverted and explains the rising expectations for a quarter-point cut at the March Federal Open Market Committee (FOMC) meeting. The Fed simply cannot ignore the radical move in bond yields when going out on the curve.
We’re in a very unusual time, having gone through a surge in inflation, a rapid rise in interest rates and an economy that has demonstrated surprising strength, but at what price? There is now over $310 trillion in debt around the globe, most of it on the balance sheets of governments and central banks. Unwinding this debt behemoth without triggering recession is the next big thing facing central banks, which will play out during 2024 in a big way. For now, though, the market is on good footing supported by brisk insider buying, stock repurchases and bullish fund flows out of money markets and into equities that should make for a rosy and cheerful finish to the year.
