The Return Of The “Fed Put” Is Supporting Stocks
Stocks ended the week on a positive note following yet another solid jobs report. Yes, the bears can highlight some cracks in the labor market like the large divergence between full-time and part-time jobs or the slide in temporary employment, but those arguments pale in comparison to the positives underpinning employment at the moment. Otherwise, it was a rare down week for equities last week with the small caps as measured by the Russell 2000 lower by -3.0%, the Dow fell -2.3%, the S&P 500 slipped -0.9%, and the Nasdaq Composite slid -0.8%. With regard to equities, we remain in a state of no-mans land as the major averages consolidate the torrid gains to kickoff the year.
Strong fundamentals have validated the rise in equities (valuations aside) with economic growth continuing to trend above potential, a strong labor market, and earnings surprising to the upside. Another supportive variable is the Fed. On the surface it may seem odd to see the Fed as a positive, with monetary policy on the margin evolving in a less accommodative fashion as the year progresses (6 cuts down to 3), but the most important thing is not the exact number of cuts, but the confidence that the Fed will cut if growth slows. This is the message being conveyed by Chairman Powell in recent speaking engagements:
"The recent data do not, however, materially change the overall picture, which continues to be one of solid growth, a strong but rebalancing labor market, and inflation moving down toward 2% on a sometimes bumpy path."
If the market really starts to think that the Fed won’t cut or their bias shifts from accommodation to ‘more tightening needed’, then that’s where I think equities are extremely vulnerable to some painful downside. But as long as growth remains resilient and inflation, while ‘bumpy’, is trending down, then investors should be viewing capital markets through a recovery/cyclical upturn lens. However, it’s important for investors to keep in mind that risk and return is a two-way street. The longer the data shows the U.S. economy expanding above potential the higher the probability rises for ‘no Fed cuts in 2024’. The likeliest scenario is somewhere in the middle with the ultimate cut path nowhere close to as deep as what had previously been assumed by the market.
Without question markets have repriced (some more than others) to this new rate path, but make no mistake this milder / more protracted cutting path is a defacto ‘tightening’ relative to prior ‘loosening’ expectations. Recall fed fund futures in mid-January were pricing in 168bps of Fed cuts for 2024, and they are now down to roughly 62bps by December 2024 (that’s a little more than two cuts). The last time rate-expectations for 2024 were this low the Nasdaq was trading below 15,000 or roughly 10% lower than Friday’s close.
The big data point of the week will be Wednesday’s CPI inflation report followed by PPI on Thursday. On Friday we’ll get the kickoff of Q1 earnings season with the big U.S. banks. Not to mention it will be a heavy week of Treasury auctions which will weigh on liquidity: $58 billion in 3-yr, $39bil in 10-yr, and $22bil in 30-yr.
At 5,210 the S&P 500 is trading 2.5% above its 50-day moving average of 5,082 with the number of constituents in the index trading above the 200-day moving average continuing to expand. This is indicative of a healthy market, should this breadth measure flip and the S&P 500 continue to grind higher, then we’d have something to worry about. While breadth metrics are not a concern, rising oil prices, and interest rates continuing to climb are viable headwinds worth keeping an eye on. As for earnings, it will be interesting to observe the markets response to beats and disappointments. I’d argue that the bar has been set pretty high with the forward P/E multiple up to 20x from 17x last October – a rise in price of more than 25% in the S&P since then without a corresponding increase in earnings will do just that. What is very interesting to see heading into earnings season is the lopsided nature of analysts’ estimates: earnings for the Mag7 are forecast to grow +38% YoY versus a -2% slide for the rest of the S&P 500. Let’s see what happens when we get the actual numbers.
It was a very rough week for long-term Treasuries last week with the yield on the 10-yr T-Note jumping nearly 22bps to 4.42% - its highest close of 2024. The yield is up +56bps since the lows in February and the technicals suggest a push up to 4.5% is in the cards. The drift higher in rates is not a huge surprise with odds for a June rate cut falling to 50% from 75% before Friday’s jobs report was released and odds of July being the first cut at 86% (September is the first month with 100% odds of a cut). In simple terms, this implies that markets are coming to grips with the expectation that two cuts may be all it gets in 2024 and potentially none if the data holds up.
Goldman Sachs Tony Pasquariello made some interesting comments on CNBC last week in regard to 10-year yields. Suggesting that a 2-standard deviation move in the 10-yr yield (equivalent to roughly 60bps today) over the course of a month is when friction starts to occur in capital markets. Should we see a move up into the 4.75% area in the 10-yr, I suspect we’ll see the overall character of equity and fixed income markets change for the worse.
Looking around at other markets, we have the WTI oil price closing in on $87/bbl, its highest price since November 2022 other than a two-month stint above here last September. Geopolitical fear is driving some of the recent bid, but there also is an element of potentially not enough supply being able to come online to meet peak seasonal demand.
Then there is gold which has taken on a bitcoin like mystique rising day after day. Should it close higher today (up +0.5% as I type) gold will have risen in price in 11 of the last 13 trading sessions and is now up $280, or +13.25% this year. The precious metal has risen in three consecutive weeks and is up in six of the past seven weeks. It is up +29.5% from its 52-week low of $1820/oz on October 5th and outperforming the Dow, S&P 500, and Nasdaq Composite ytd. The below chart plots the ytd performance of oil, gold, copper, and the Nasdaq with gold outshining everything but oil.
As for gold, my view continues to be that it is sniffing out the era of ‘fiscal dominance’ no longer being conspiracy theory but an ugly reality. You may not like it or agree with it, but you’ll have to deal with it. Neither the populous in the U.S. nor politicians in either party have the tolerance for the pain we’d incur to reign the deficit in as it would require raising taxes and/or cutting spending. The Fed talking rate cuts at a time when nominal GDP growth is 4- 5% is incongruent with economic theory when you’re talking about an economy as mature and large as the U.S. But gold is saying something with its unrelenting rise and my guess continues to point towards it expecting an inevitable combination of QE, yield curve control (YCC), or outright ‘debt monetization’.
Irrespective of the ‘everything seems to be in a good place’ backdrop for equities at the moment it’s important to recognize that this isn’t a unique view. Rather, this has become the widely held consensus view. Moreover, even with the ‘Fed Put’ being back on the table as a ‘get out of jail’ free card for markets and the economy when they need it, that doesn’t mean it won’t require some pain before they actually do play it. Sentiment and positioning are very stretched at the moment. The just-released Investors Intelligence Survey moved further into extreme territory in the latest week. The bull camp expanded to a nosebleed 62.5% from 60.6%, while the bear share was pared to 14.1% from 15.2%. That 48.4 percentage point spread has taken out the December 2021 level (remember what happened next), to now match where it was in January 2018 (marked a short-term peak). Anything over 40 percentage points in the bull-bear spread is a sign of herd mentality that we all need to be aware of. Being bullish, while the right call over the past five months and likely to continue to be so, is a very crowded position today. A good gut check or an extended period of consolidation (while never fun) would be a more constructive development for investors than another leg higher right here, right now.
I won’t be penning a missive next week as the kids are off for spring break and I’m going to be mixing in a little business and personal travel with the family. As always, don’t hesitate to fire away with any questions or tell me I’ve lost my mind – I enjoy ‘almost all’ the interaction.
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