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Weekly Update (12-19 : 12-26): Markets Rejoice
· The Fed made a distinctive pivot in its policy meeting last week, opening the door for rate cuts in 2024. Fed Governors including the SF Fed have said that financial conditions are now tight enough that it may necessitate several interest rate cuts next year.
· The tone of Powell’s speech last week was markedly more measured in terms of his unwillingness to push back against financial conditions that seem to be easing quite rapidly, as evidenced by equity prices that remain on a trajectory upward, and bond markets that seem to be pricing in 4-6 interest rate cuts for next year.
· If the “Soft Landing” narrative has now become the dominant one in the market, it would portend the broadening out of a relatively concentrated equity market meaning, other areas besides just mega-cap tech or magnificent 7 stocks should win in such an environment.
· While we believe the Fed is correct in assessing that no further tightening is necessarily going to be the case moving forward, we are somewhat surprised and almost skeptical at the amount of easing the market is pricing in. Rapid cutting of rates would signal a significant economic deterioration that we don’t see in the current data and wouldn’t be a good thing for equity markets.
· A recent macroeconomic forecast from Goldman Sachs, who was one of the few investment banks to get the call right in 2023, sees core inflation moving gradually to 2.2% by the end of 2024; led by decreases in housing and rents, which have been the key sticky components to inflation thus far.
· One of the detractors from a potential soft-landing could be continued volatility in commodity prices stemming from the Middle East. For instance, we are already hearing stories of major energy suppliers having to re-route around certain parts of Africa and the Red Sea. To the extent that such moves may trigger supply disruptions, large energy producers are all but certain to pass such costs along to consumers. Energy disinflation has been one of the major contributors to inflation coming back down to target, so it will be very important to gauge whether the decreases at the pump will “stick.”
· The final two weeks of trading in the stock market are generally periods of relative illiquidity – similar to the summer period, when many traders and money managers go on vacation. We would not be surprised to see volumes dominated by further tax-loss selling in some of the weaker stocks this year.
· In our view, Tom Lee of Fundstrat’s prediction of 12-15% baseline return in 2024 looks realistically achievable. While it seems unlikely that the Magnificent 7 will have another year of 70-80% + gains, other parts of the tech sector have lagged behind this performance and sectors like financials, consumer staples, and healthcare have yet to fully recover. As such, headline indices like the S&P 500 and Nasdaq still sit below their early 2022 highs.
· Based on the “broadening of markets” thesis, which we subscribe to, we believe that industrials will do well as evidenced by PMI’s that are bottoming and starting to inflect upwards. Healthcare will do well (if the landscape for M&A improves, which it should). Financials will do well as trading desks and investment banks flourish as rates fall, and in general, small and mid-cap stocks which are highly sensitive to interest rates, can do very well. Technology should continue to do well.
· Going into 2024, the month of January is typically a seasonally very strong month. Whether or not next month is strong may tell us a lot about how 2024 as a whole will shake out. We remain open-minded about what the dominant positioning in 2024 is likely to be.
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