Generic market wraps published on Friday described an unremitting equity melt-up deaf to the shrill protestations of bubble-decrying skeptics.
Trading beyond 5,000, the S&P was 800 points above the most bearish year-end 2024 Wall Street forecast as it stood headed into the new year. US shares would need to fall 16% to match JPMorgan’s original 2024 target.
Earlier this week, in an asset allocation update, the bank reiterated a defensive stance citing familiar concerns, including the lagged impact of policy tightening, stubborn inflation and concentration risk associated with “Magnificent 7” dominance in cap-weighted indexes.
JPMorgan’s team might’ve been the most cautious, but they weren’t alone in seeing their prediction rendered increasingly bearish versus a rally that refused to relent. The figure below gives you a sense of how stocks’ early-year run turned most of Wall Street into bears (implicitly, via the disparity between top-down strategist targets and spot equities).
Skepticism is pervasive, which in part explains stocks’ inexorable climb. The world’s benchmark risk asset par excellence is within 4% of the most bullish strategist target for year-end.
The problem for skeptics is simple: Notwithstanding inflation that’s still too high versus arbitrarily defined targets (and relative to our recency bias which pretends low macro volatility is the rule rather than the exception), the US macro picture continues to evolve consistent with a soft landing. Friday’s annual CPI revisions from the BLS were no exception. The adjustments came and went with no drama. 2023’s disinflation was real, or as real as it can be in the context of “lies, damned lies and statistics.”
“There is little doubt that Jerome Powell and his colleagues will breathe easier if [the] CPI revisions maintain the majority of the deceleration trends of 2023,” JonesTrading’s Mike O’Rourke wrote, ahead of the release.
Earlier this week, O’Rourke documented various reasons for the economy’s resilience in the face of what, on the surface, counts as one of the most aggressive tightening campaigns in the modern history of developed market monetary policy. Those reasons are familiar, and include a very low share of variable-rate debt on household balance sheets and a corporate sector which locked in ultra-low rates while terming out debt profiles.
The result, O’Rourke wrote, is a “conundrum,” illustrated poignantly by the figures below. “The current level of the Fed funds rate is in the 81%ile” looking back to 1990, he noted, adding that in theory, that should “mean tight financial conditions.” Only it hasn’t.
As the figure on the right shows, Bloomberg’s US FCI is in the 91%ile percentile for easy financial conditions over the same lookback.
O’Rourke (and he’s hardly alone in this regard) believes policymakers, for all their pretensions to monitoring a variety of indicators to assess the degree of restraint operating on the economy, ultimately view the Fed funds rate as the determinant of financial conditions. As he put it, “Everything is a nail when your only tool is a hammer.”
He went on to offer a word of caution on the off chance the “Fed Listens” (get it?): “The Fed needs economic releases and financial conditions to align with the interest rate stance before it considers altering monetary policy, otherwise they are simply hoping for a good outcome without comprehending the drivers.”
The Fed has lost control. Again. How many times will they rescue markets b/n 2018 and 2025? Does anyone at the Fed pay any attention to work similar to what H presents here about market structure, vol lever, etc., etc.? Doesn’t appear so.
This march up feels like early 2020. Back then, AAPL warned–and was ignored. No similar shot across the bow–yet. Maybe market snaps soon, maybe not; no idea. But I suspect the longer the march continues, the uglier the snap down. Fear not, it’s an election year so there’s good reason to keep pushing the envelope and trust in Fed to cover…and Yellen to demand Fed’s cooperation. Maybe.
I think I should be clear, though: You can’t make investment decisions based on the whole “They never learn!” derision vis-à-vis the Fed and bubbles. At the end of the day, you want to participate in bubbles, at least as they inflate, not sit in cash and cry foul. Think about all the people (and there were a lot of them) who spent years insisting the S&P would revisit the March 2009 lows once the Fed’s monetary “experiments” inevitably backfired. How’d that turn out? Some of those same people are still around today, saying the same general thing, although they’ve given up on the GFC lows argument by now.
Agree 100%. Thanks for the clarification. I don’t invest based on the undeveloped ideas expressed in my cryptic comments but some might misunderstand.
Sadly, many people–perhaps more than those who don’t participate in the bubbles–overstay their welcome and get scalded. They often do so, based on my anecdotal experiences communicating w/ friends, overhearing conversations during runs up (like now), etc., b/c they buy into the surface level narrative (e.g., “AI is different and will play out over many years”). They hear that narrative from financial advisors whether via web pages or directly in conversation. I suspect the vast majority of people participating in moves higher and never considering an exit, and their “advisors,” rarely read work such as yours that takes a much deeper dive into market structures and their complexity (structurally and beyond).
I suggest the Fed’s responsibility to maintain financial stability should include a longer-term perspective allowing short-term vol, price discovery, and greater uncertainty. In other words, target markets and vol explicitly and let momentum folks know it’s a two-way street. Mandelbrot, Hayek, and others might suggest that would make things worse; I don’t know. I don’t have the evidence to demonstrate it definitely, and am not sure anyone could, but it “feels” like markets have a greater tendency since the GFC for Minsky moments.
Names included only for those who may be interested in reading about them. I honestly don’t care what Minsky or Mandelbrot said. About anything. I sound a little like you H but nowhere near as smart or knowledgeable–seriously.
So…I feel sad for the people who get scalded. And I believe the Fed (and SEC) could do a better job protecting the “little” people from structural disruptions–or at least talking about them to help educate laypersons about structural and other risks. Interestingly, simply talking about such structural risks more frequently might lead some momentum players to tweak their models.
To sum it up, the economy is not responding to higher rates as the street or Fed models predicted. Historicals no longer seem applicable. Humility rather than certainty is the best approach for investors and policymakers alike.
Isn’t the economy not responding to higher interest rates because the rates aren’t high enough? Fiscal policy is throwing off money into the system. Corporations and families with housing refinanced when money was virtually free. The US economy is still booming because of some unique COVID policies and because interest rates aren’t the only factor that matters.
It’s kind of tautologic but it needs to be said. Interest rates aren’t the only macro lever.
I feel like I am in a raft going down the Colorado River, on high alert but unaware if Class 5 rapids are waiting for me around the bend.
Meanwhile, this is one of my best rides, ever.
Bloomberg FCI is mostly spreads (HY/UST, CP/bills, etc), rest is volatility and stocks. FF rate is high relative to recent history but credit/equity fear is low. Very interesting combination. Suppose inflation and economy behave and in a few months Fed cuts FF into already loose ultra-FCI. Who would like to be short then?
The market is broadening out.
Not necessarily in the sense that other sectors are beating tech or that the 493 are beating the 7. The relative performance game is still hard.
Rather, in the sense that more and more industries and individual names, including many away from tech, have “up and to the right” charts with positive revisions. If you screen the S&P 1500 for momentum, absolute not relative, it’s increasingly abundant.
To the extent the previously narrow market was a warning, that warning light has been turned off.
To put numbers on it, of the SP1500 industries, ~30% pass my (simplistic, amateurish, etc) screen for momentum. <10% pass my screen for inflection.
Well, at some point, all that consumer spending got to show up somewhere…
I’m terrible at timing things (already sold my NVDA, oops!) and Mr H’s right that fighting (hopefully by doing nothing because shorting is a fast path to bankruptcy) an irrational rise is a fool’s errand.
Mostly I read here and watch/learn because I do believe the underlying mechanisms are logical and are happening: high interest rates hit SVB and would have taken out more banks without the “free swapsies”, companies are going bankrupt (and VC’s under pressure), Commercial (and MultiFamily) Real Estate is slowly unwinding too.
China did not dodge the demographic challenge nor their real estate bubble – albeit slowly (but very visibly despite China’s notoriously opaque and manipulated numbers). Maybe those investors found US equities but eventually all of the dominoes will fall…
So the real game is trying to identify which trigger or catalyst finally pulls the rug out 😉
Friday night report from NYC: the kids (Gen Z and young millennials) have disposable income and are hitting the restaurants and bars. They can’t afford housing, but that doesn’t seem to be a huge concern.
Laissez le bon temps rouler.