Don’t Fight The Tape, But Know Where The Off-Ramps Are
Investors are kicking off the holiday-shortened week with a stamp of approval on President-elect Trump’s decision to appoint Scoot Bessent as his Treasury Secretary. Market practitioners see Bessent as a well-rounded choice with a deep understanding of global markets and how to use that knowledge to navigate the complexities of the U.S. fiscal position and Trump’s economic agenda. He is viewed by many as an individual who will serve the American public as an adult in the room and thereby temper concerns that economic policy under a second Trump term will head down some deep, unknown path. Even if all that is true, it still begs the question of how much power any person wields with a leader like Trump. That’s not a dig at the incoming President but rather an acknowledgment that he has his vision of what he got elected to do, and I can only imagine he feels emboldened to carry it out more forcefully in his second and final term.
For those unfamiliar, at the heart of Bessant’s policy view is his 3-3-3 plan: achieving 3% real GDP growth with 3% deficits and pumping 3 million extra barrels of oil. Both aspirational and straightforward – what’s not to like? Let’s hope it can become a reality because such a backdrop likely has the economy in a good place if achieved. Nevertheless, we are seeing a relief rally across markets as we kick off the week. Equities are up on both a show of confidence and relief that a more extreme candidate wasn’t appointed. Bonds are rallying with yields falling on the view that the right balance of stimulus and deficit reduction will be struck, and the dollar is seeing a bought of profit taken after what has been a torrid run to multi-year highs.
As for last week, it was impressive to see equity markets perform as well as they did with Nvidia flaming out following its earnings report. Not that it wasn’t a solid report out of what was the largest market-cap company prior to its release, but it just wasn’t able to exceed what have become extremely lofty expectations and a very high bar. Beyond Nvidia, we also had the rest of the Mag7 struggling (Alphabet the biggest culprit with its anti-trust woes front and center), yet the rest of the equity market didn’t bat an eye. The S&P 500 and Nasdaq Composite rallied +1.7% on the week. The Dow gained nearly +2.0%, and the small-cap Russell 2000 recouped its slide from the prior week by ripping +4.5%. The improvement in breadth is evident with the equal-weighted indices for both the S&P 500 and Nasdaq 100 outperforming their market cap-weighted versions. On top of the strong showing in the equity markets we had Bitcoin ‘mooning’ +10% on the week as it approaches the $100,000 price, not to mention being up nearly 50% in the past four weeks. Gold was quietly up +5.6% last week but remains in a state of consolidation around the $2,650/oz level as it digests its +25% increase since the start of the year.
That said, investors need to recognize how different the setup is going into 2025 compared to the start of 2023 and 2024, years when the S&P 500 has gained more than 20%. Positioning and sentiment loaded up on the bullish side of the boat as can be seen from the following chart of Goldman Sach’s equity sentiment indicator pushing in “stretched” territory. This metric measures equity positioning across retail, institutional, and foreign investors which is at its highest reading in more than two years.
Corroborating the Goldman sentiment gauge is a question from the Conference Board survey which asks U.S. households about their outlook for the stock market in which a record high 51.4% of Americans think stock prices will move higher.
Given that a record-high percentage of Americans think stock prices will move higher from here, it should come as no surprise that Americans hold a record share of their assets in equities (source data via the Federal Reserve with chart compiled by Goldman Sachs). What stands out to me with this data is not the overweight exposure to equities, given how well they have compounded over the past fifteen years; it’s the minimal exposure households have to gold.
Look, I don’t point this out to sound an alarm bell but rather to encourage investors to exercise a modicum of restraint and discipline at the moment. On a tactical basis, I expect the equity market to continue to rally through the remainder of the year and into the first half of January. So, I’m not suggesting investors fight the tape. However, on a strategic basis, I am becoming more cautious about the equity market with valuations, positioning, and sentiment at or near its highs over the last decade. It just doesn’t leave much margin for error if and when something goes bump in the night.
I get the optimism and confidence coming out of the election results with the expectations of deregulation, lower taxes, fairer trade, and a stricter immigration policy, ‘Making America Great Again.’ It’s a tagline that embodies change, not dissimilar to the message delivered by Barack Obama when he won in 2008. Or what Harris was trying to convey with her campaign. However, change can be disruptive and uneven.
My caution is focused on markets and the present opportunity set, which to me looks very scarce in terms of favorable risk/reward options. Moreover, markets are priced as if implementing this policy change will be flawless—not just on a legislative basis but also on the monetary policy implemented by Powell and the Fed, which will tuck right in seamlessly. I’m not saying equities should be erratic or 15-20% lower, that S&P 500 should be trading at a 16x forward P/E multiple rather than at 22x, and credit spreads should be 100 basis points wider. Markets are where they are, and they could care less where I think they should be, but it's my job as a steward of other peoples capital to strike the appropriate balance between capital appreciation and capital preservation, given the opportunity set, and I find myself leaning more towards the latter as we move into January.
Back to policy and the incoming administration. The sequence in which President Trump delivers his policies after taking office on Jan. 20 is critical to financial markets. The current market narrative assumes the best-case scenario where Trump’s pro-growth agenda of tax and budget cuts spur GDP growth to 3% a year. Immigration reform and having a positive impact of some form on the Ukraine/Russia war are seen as the first two priorities, followed by cutting regulations and then getting the wheels turning on taxes (extending prior tax cuts and taking a stab at reducing corporate rates further) – all designed to spur 'animal spirits.' Once that is in place, the administration would start looking at tariffs to protect U.S. industry. However, the risk to this narrative is that the administration moves first on tariffs. One possibility being touted is that Trump imposes full tariffs upfront and then negotiates down. That could jolt the markets or, at a minimum, would certainly raise questions among investors.
You can’t look at the Trump agenda in isolation, as what, when, and how it gets implemented will have ripple effects throughout the financial system. These ripples will impact the Fed’s reaction function, and even though the futures market is repriced for just three more rate cuts by the end of 2025, there is a chance we don’t even get that many. Sure, Trump will embark on a deregulation thrust as he did in his first term, which will help with inflation and the labor market. However, that affects inflation glacially in contrast to the immediate effect tariffs can have. Tariffs are a one-off price shock, but the Fed will be worried about the second-round impact on wages. Of course, the labor market response will hinge on the degree of slack, so a jobless rate closer to 5% will obviously be different than today’s 4% level. But therein lies another dilemma as Powell and the brass at the Fed are on record in saying they don’t want further signs of a softening jobs market, but this may be what it will need to see to stay on a rate-cutting path if the tariff hikes go through as planned.
Except for Austan Goolsbee from the Chicago Fed, the vast majority of FOMC officials have been pushing back on the need for much more in the form of policy easing. The market has already taken out five moves by the Fed, which triggered an +75 basis point backup in the 10-year T-note yield. Recall that at the interim high on the 10-year T-note yield in April at 4.7%, futures were pricing in a 4.4% funds rate for the end of 2025. At the 3.63% nearby low in the 10-year yield in September, futures were discounting a 2.8% funds rate for December 2025. And now, the futures have repriced the Fed to 3.8%, and it is this reassessment of the monetary policy outlook that has caused the 10-year Treasury note yield to back up over +75 basis points in just the past two months to 4.4%. If the Fed stands pat here, at the same end-2025 funds rate level that was being discounted last April, then it would make sense for the yield on the 10-year T-note to move back up to 4.7%. I doubt the equity market will like that. The Fed seems to be caught in a box now and is sounding more circumspect, all of which makes sense to those thinking through the complexities of the road ahead, but it's hard to identify such indecision in risk assets where the ‘number go up’ mentality appears to have taken over the zeitgeist.
The last thing I want to hit on is debt and deficits. I’m more than curious to see what Musk and Ramaswamy come up with at the newly formed Department of Government Efficiency (DOGE). I’m confident they will find some cost savings, but I don’t think they will get anywhere close to the $2 trillion that has been thrown around. Think about it, that would eliminate all non-essential spending – not going to happen and even if they could it would without question tip the economy into a recession. What investors need to be thinking about is the fiscal cliff that is already barreling down on the economy as the calendar flips from 2024 to 2025. We are nearing an inflection point for debts and deficits where the rate of change is set to peak and rollover (deficits will be less big and outstanding debt level will increase at a slower rate). This is a negative marginal impact on economic growth and will need to be made up from somewhere else in order to keep the soft-landing alive. We’ll see and while it’s the prudent financial move to make, be careful what you wish for. Since the Covid pandemic U.S. exceptionalism has been driven in large part by Uncle Sam borrowing from the future to incentive consumption and growth today. It's a big reason why the U.S. economy and U.S. asset prices have been handily outperforming the rest of the world – a disruption to this trend, even if at the margin, is something to watch.
As for some closing thoughts to finish up this weeks missive. Don’t fight the trend in risk assets at the moment. Central Banks around the world are looking for excuses to be accommodative (even if it has been difficult to maintain such a posture over the last six weeks), economic growth remains strong, corporate profits are growing and broadening, and the labor market remains strong. The biggest concern is none of this is an unknown. Investors are positioned for such a setup and most asset prices reflect such a goldilocks environment. The challenge investors face from here is measuring and mapping when/if this changes and having a plan to adjust when/if it does. Now is not the time to reach for return. Now is the time to be patient, disciplined, and prudent.
I’m going to take next week off from penning a missive. From our families to yours, Happy Thanksgiving, safe travels, and we hope you enjoy some quality time with loved ones.
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