Evening Brief – 12.05.23
December to Remember – or Forget?
What is obvious following the 10%+ November U.S. equity rally is that market mood has shifted dramatically, with lower inflation data and the belief that the Federal Reserve’s policy maneuverings will likely escape a severe recession sparking a flood of new buying.
The popular belief is not only that the Fed has stopped raising interest rates, but that the data indicates cuts will occur as early as spring 2024. The CME FedWatch Tool now predicts a 55% probability of a rate cut in March.
The U.S. 10-year Treasury yield has fallen dramatically roughly 80 basis points in a five-week period and the yield curve has inverted anew, which explains increased expectations for a quarter-point interest rate cut.
Generally better-than-expected company earnings releases from the technology sector have boosted investor confidence to the point where enthusiasm is spreading to the laggards such as small caps and banking sectors.
Many economists are divided on the economic forecast for early 2024, which is mostly determined by consumer health. Bond yields have fallen in recent days and weeks, which has had a good knock-on effect on the mortgage market, with applications up for four weeks in a row.
However, housing prices remain high, as do costs for professional services such as insurance, repairs, medical, education, travel, and so on. Wages rose in 2022 to keep up with inflation, and those increased labor expenses will invariably be passed on to consumers in the form of higher pricing for products and services.
One could claim that inflation is likely to reach a 3% annual rate during the current quarter. However, meeting the Fed’s 2% target would necessitate a sharper decline than the market is pricing in.
Pershing Square hedge fund manager Bill Ackman predicts a rough landing in the first quarter of 2024, claiming that the consumer would slam on the brakes due to being overly leveraged. So far, the consumer has proven the critics incorrect.
Two notable developments have occurred in the last week, sparking even more optimism. The Russell 2000 Small Cap Index and the Regional Bank Index rose sharply. The broader participation in the market is certainly encouraging. While a 5% pullback is possible, the current positive environment likely calls for further stock exposure.
We have seen a rapid rise in inflation, a swift rise in interest rates, and an economy that has shown remarkable vigor. But at what cost? Global debt has already surpassed $310 trillion, with the majority of it held by governments and central banks. Unwinding this debt without causing a recession is the next major challenge that central banks will face in the coming year.
For the time being, however, the market is on solid ground, buoyed by aggressive insider purchasing, stock repurchases, and strong fund flows out of money markets into equities.