The S&P 500 hit a new record on Friday.

Some readers (most, I hope) will recall that as US equities melted up in December, extending gains after a rollicking November rush, I repeatedly suggested that notwithstanding stretched positioning across key systematic investor cohorts, massive inflows to US equity-focused ETFs and mutual funds and the most bullish individual investor sentiment of the year, a meaningful drawdown was unlikely in the near- to medium-term.

The reasoning was simple: A demonstrable lack of demand for downside protection suggested many large, fundamental/discretionary investors actually weren’t running high exposure. In fact, demand for upside optionality suggested the opposite: Some investors were under-exposed into the melt-up.

Fast forward six weeks, and there was no correction. The options landscape is shifting a bit, but regardless of what happens from here, it would’ve been a mistake to fade the rally in early December when more than a few observers suggested equities ran too far too fast and were destined to correct imminently.

The drawdown which began two years ago as the Fed embarked on the most aggressive rate-hiking campaign in a generation is history.

As Nomura’s Charlie McElligott wrote Friday, selling vol was actually “a smoother ride than holding outright” stock longs over the past month unless you were an overwriter in which case… well, here’s Charlie:

Anything that involves selling puts [was] a ‘win’ over the past year on high Sharpes because the spot tape simply can’t hold a selloff, let alone crash, but selling calls has been grim, as investors are forced to chase back into the underlying, which then becomes part of the feedback loop contributing to overwriters being forced to repeatedly cover their short call strikes as they’re rallied-through.

So, all melt-up and no real melt-down. Even the August-October selloff felt controlled. It certainly wasn’t disorderly.

Anyway, US equities are “rationally” skating to the puck, as BofA’s Michael Hartnett put it Friday, where that means anticipating lower policy rates.

Although rate-cut pricing was trimmed over the week, it’s important, I think, to note that the best-case scenario is insurance cuts with no recession, and you could easily argue that the ~30bps which came out of cut pricing was hard landing/recession premium. We can lose that and be fine, even as the repricing is “significant,” as McElligott put it (see his chart header below).

Of course, we don’t want another “re-heat” scenario either. This is a balancing act. We need enough cuts to justify the recent re-rating in equities but not so many cuts that some future-dweller, looking back on the realized trajectory of Fed funds this year from 2025, would be able to determine, with no knowledge of how the macro panned out, that a recession “must’ve happened.” In short, we need “Goldilocks.”

Happily, Friday’s University of Michigan sentiment report was a Goldilocks release: Consumer moods improved dramatically for a second month and inflation expectations receded further.

“More ‘too strong data’ will continue bleeding the left-tail ‘deep Fed cut’ mode, and instead fatten the ‘soft landing’ / ‘slow disinflationary cuts’ path, or perhaps even reintroduce the ‘inflation re-acceleration’ / ‘no cuts’ part of the distribution,” McElligott went on.

Judging by the S&P’s Friday summit push, it’ll take an even more significant de facto tightening impulse (i.e., additional paring of 2024 rate cut wagers) to derail stocks, which is to say the data would need to come in hot enough to make the Fed rethink 2024 cuts altogether.

Or the opposite: A sudden and dramatic deceleration in the macro that finds markets rapidly pricing (back) in hard landing insurance to an extent that investors start worrying about a double-dip earnings recession.