12/23/2024 Market Strategy
Shake, Rattle, and Roll
Equity Markets Start the Week in Recovery Mode After a Spate of Data Indigestion
Key Takeaways
- The equity market sold off last week on concerns about the path of interest rates as the Fed’s “dot plots” suggested just two more rate cuts next year rather than the three previously plotted and the four or five cuts that the futures market had priced in.
- Last week’s PCE deflator inflation report (the Fed’s preferred measure) showed the “core” (excluding food and energy prices) rising just 0.1% in November.
- Retail sales showed a solid gain in November, suggesting that GDP growth in the final quarter of 2024 could be north of the 3% rates of Q2 and Q3.
- This week brings data on consumer confidence and the Christmas Day holiday on Wednesday.
With just six trading sessions (four of which occur this week and two sessions in the week that follows this one) large cap equity indices find themselves slightly off from their recent record highs but fairly recovered from a spike in volatility that by week’s end appeared to have been countered by fundamentals (economic, corporate, consumer and employment) that remain pretty darned good.
So, “What Happened?” Over the course of the last two weeks the equity markets first “took a trim” to stock prices ahead of the release of CPI and PPI data (pretty normal in our view) after which they rallied some only to run into some volatility last week to “take a haircut” after the Fed delivered the rate cut that ironically just about everybody in the markets (or so it seemed) had expected.
The VIX, also known as the “fear gauge,” spiked over the first three days of last week to rise from a closing level of 13.81 on Friday, December 13 to 27.62 last Wednesday
In our view, last week’s turbulence was generated by a market tantrum that started with the bond market’s reaction to the Fed’s decision to cut its benchmark interest rate by 25 basis points (or 0.25%). Markets appeared to react to the rate cut decision more in response to a read of the dot plots (rate expectations by economists at the Fed) to conclude that the Fed would cut fewer times in 2025 than it had earlier suggested---likely cutting just two times instead of three times in 2025---and even fewer times than traders had aggressively priced into their positions ahead of the FOMC meeting.
The result? A perfect cocktail of volatility -- or similar to what Ebenezer Scrooge attributed his indigestion to (a bad piece of cheese) earlier in the night and before the Ghosts of Christmas Past, Present, and Future appeared to him resulting in his change of heart.
The 10-year Treasury yield moved higher from market close on Monday, Dec. 13 to market close on Wednesday, Dec. 15 by around 12 basis points or from 4.40% to 4.52%. The move rested on expectations that the Fed was opting on a “higher for longer” regime in determining where rates would go.
The yield jump in the 10-year Treasury does not look like much written or typed out on a piece of paper until the added cost to the price of borrowing is considered. Feed those numbers to “the algos” and you’ve got a Charles Dickens’ “Christmas Carol” kind of drama in bond and stock price movements.
And then like Scrooge racing down the staircase to give a sizeable tip of a Christmas present to his housekeeper (and scaring the daylights out of her with his positive change in personality from the visits of the three ghosts) the stock market began to rally somewhat on Thursday and work its way out of its Fed rate decision- funk to end the week with the Dow Jones Industrials, the S&P 500 and the NASDAQ Composite off just 2.25%, 1.99%, and 1.78% respectively from where they had closed on December 13.
The mid-caps and small caps did not rally as much as the large caps as the bond market saw yields tick up a bit further putting the timing of when the mid- and small caps will rally further on down the road with their relative sensitivity to rising rates likely a near term obstacle.
It’s long been our view that market economic and historical context can help investors navigate turbulence.
We are not apologists for market behavior but realize that it’s never easy transitioning from periods of events of the magnitude of the Great Financial Crisis, the Covid-19 crisis, periods of “free money” created by monetary policy and fiscal policy response to crisis, and record inflation highs after elongated periods of easy monetary and fiscal policy.
The distance to some kind of new normal takes time to plot and travel. In our view, normalcy is not forever in the distance thanks to the Federal Reserve which so far has been able to avoid a recession over the course of the rate hike cycle that started in March of 2022 through the unwinding of restrictive rates that began in September and continued in November and December. We expect its policy will remain highly sensitive to its dual mandate as it has been throughout the rate hike cycle and currently in this period of easing.
Volatility comes with change. Even as things improve there can be setbacks or unrealistic expectations that stir the pot; but a detour does not usually a journey end.
In our view the Fed this cycle has found support in the process of returning to normalcy in an economy that has and persists in showing resilience. Business, the consumer, and the jobs market along with innovations in technology remain supportive of what remains thus far a relatively soft landing after some significant periods of turbulence in the economy and the markets.
Ultimately the equity markets look for revenue (sales) and earnings (profit) growth while the bond market looks for stability in interest rates. Heightened geopolitical risk, domestic government spending, and the US border remain among the challenges ahead.
In our view, there’s enough risk and opportunity on the landscape to warrant the thought that the markets are likely to continue climbing the proverbial wall of worry through the end of this year into and through next year.
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