Asset prices are experiencing a hangover to kick off 2024 after the nine-week rally in just about everything to end 2023.  The S&P 500 slid 1.52% last week while the Dow slipped by 0.59%.  The big winners in the year end-rally, the Russell 2000 small cap index and the Nasdaq are the two indices having the hardest time getting out of the gates in the new year, declining -3.75% and -3.09%, respectively last week.  Yields are also pushing higher with the yield on the 10-year T-note moving back above the 4% level after slipping below 3.8% on December 27th.  Higher yields are pressuring gold with it declining to $2,030/oz from an all-time high of $2,093 in late-December.  It’s too early to tell whether this is just a healthy pause/consolidation following what was a dramatic short squeeze induced performance chase into year-end or the start of a more substantial slide. 

What can be quantified is valuations moving back up to stretched levels, sentiment reaching a bullish climax, and positioning stacked back on the bull side of the boat.  The top left panel in the below charts indicates the amount of equity buying or selling to be done by CTA’s depending on the move in the S&P 500 (up or down) – in plain speak it shows that there isn’t much buying if the S&P 500 rallies from here, but there is a whole lot of selling to occur if the S&P 500 sells off.  The top right panel measures the equity exposure among CTA funds which are approaching their max long exposure relative to the last eight years.  The bottom left panel is the AAII sentiment poll measuring the spread between the bulls (48.6%) and the bears (23.5%) – a spread of 25 is about as stretched as this metric gets looking back over the last several years.  Lastly, we have the CFTC positioning chart showing institutional investors’ equity exposure is back up to levels that preceded the pre-covid sell-off in early 2020 and the equity market peak in 2021.  As the saying goes, forewarned is forearmed.  This doesn’t mean a crash awaits, but it does mean the soft-landing expectation is fully baked into asset prices.  Now it’s up to incoming data and policy actions to corroborate that expectation or something occurs to rock the boat that unwinds this widely expressed view.

As for last week’s economic releases, to me it was a mixed bag with a tilt towards disappointing rather than constructive.  The jobs report released on Friday looked good on the surface with the headline print of +216k jobs being created in December, but once again we saw negative revisions to the tune of -71k for November and October.  For those keeping track we’re now talking about an epic total of -443k in downward revisions to the initial job prints in 2023.  Too bad all anyone cares about is the initial release and then it’s on to the next number, but what we are learning from the revisions is that the labor market isn’t nearly as healthy as the initial prints would lead you to believe.  Sure, an unemployment rate at 3.7%, the U-6 measure at a solid 7.1% rate, and average hourly earnings clipping along at a +4.1% year over year are all indicative of an economy operating at full employment.  That’s great, but most things investment related focus on the rate of change and for those looking for stocks to rise even further its growth that really matters.  What we’re seeing in the labor market is a deceleration (not a contraction, yet) in the rate of change or a slowing in the pace of growth.  Moreover, an economy already operating at what appears to be full employment doesn’t have much more to offer in terms of growth.  Just maintaining such a backdrop would be nirvana for policy makers, but not so great for passive investors looking for a rising tide to continue to raise all boats.    

The economic release that really caught my attention last week was the ISM services index which slipped to 50.6 from 52.7.  Anyone paying attention is already well aware that the manufacturing sector has been in a state of contraction for well over a year now – a reality reinforced by last week’s ISM manufacturing survey coming in at 47.4 (its fourteenth consecutive month in contraction) – but for the services sector to now be flirting with contraction is a bit more disconcerting.  Another surprise within the ISM services index was the steep slide in the employment component to 43.3 from 50.7 indicating the service economy is now shedding jobs. 

In the interest of not going too far down a rabbit hole year with an analysis on jobless claims (historically low levels and a good thing) or the JOLTS data (another BLS labor report that is at solid levels but like the establishment survey, indicates slowing) let me bottom line it.  The collection of labor market data is indicative of a labor market that is fully employed, weakening at the margin, and where companies are more reluctant to fire anyone for fear of not being able to find a replacement down the road.  However, as an investor you need to keep in mind that the gorge between a reluctance to fire and a dramatic spike in unemployment can be quite wide.  Moreover, what C-suite management team is willing to risk the backlash of a massive layoff (outside of one-off reorg’s) with earnings and equity markets near all-time highs?  Give me a 10-15% sell-off in equities and I’m willing to bet this mentality will change, but not here and now. 

As for the Fed, they are subtly dropping breadcrumbs that six rate cuts priced into this year is too much too soon – comments over the weekend from Dallas Fed President Lorie Logan are the latest example.  The minutes released last Wednesday from the December FOMC meeting also provided some color on this view, “Many participants remarked that an easing in financial conditions beyond what is appropriate could make it more difficult for the Committee to reach its inflation goal.”  This is code to the markets to ‘cool your jets’ when it comes to getting too aggressive in frontrunning rate cuts and/or the Feds dot-plots.  With that in mind, markets have repriced a bit over the past two weeks where what was once a 90% probability of a March cut by the swaps market has been pared to 65%.

Look, we may very well see a rate cut as early as March but given current conditions it will take a lot for that to happen.  Either signs of recession show through more definitively with the economic data really taking a turn for the worse or we need to see the core CPI and PCE deflator numbers come in no higher than +0.1% in the next few months.  This ladder point would allow the Fed to cut rates while not theoretically loosening policy in that it would be a targeted cut to maintain a restrictive level of real rates (Fed funds rate minus inflation).  Beyond that an unexpected geopolitical event or problems in the banking system resurfacing (let’s just call it an exogenous event) would be required to get the cutting cycle underway. 

I will say this before closing the loop on the Fed, when looking at past cutting cycles; when the Fed cuts, they do so quickly and aggressively.  Going back to 2000, the Fed cut by 550 basis points (6.50% to 1.00%) from January 2001 to June 2003 with 475 basis points of those cuts happening within the first twelve months of the first cut.  During the GFC the Fed’s first cut was in September 2007 with the Fed funds rate at 5.25% and within the first twelve months they cut 375 basis points to 1.50%.  They ultimately ended up cutting rates all the way to zero by December 2008.  Then we had the 2019 mid-cycle adjustment cycle where Powell started cutting rates in August 2019 with the Fed funds rate at 2.25% due to distress in short-term funding markets (75 basis points of cuts in 2019) which ultimately culminated with the Covid pandemic where rates dropped back down to 0% (but this was 225 basis points of cuts inside of 12 months).  What I’m getting at is that when the Fed cuts, at least in recent times, they do so with gusto.  So, 5 – 6 rate cuts priced in for 2024 or about 137 basis points is actually quite tame compared to prior cycles.  I might add we have the benefit of hindsight on our side in relation to understanding how those periods played out – it will be much clearer to tell you how 2024 played out in 2025.

With nothing riveting occurring at the moment as it pertains to the data (ho hum for now), markets, or the global economy (I know, depends on what one deems riveting) I thought it would be a useful exercise to look through the calendar of events upcoming in 2024 and see what stood out as potential market moving events. 

• First up is another possible government shutdown on January 19th with U.S. debt now approaching $34 trillion (up $1 trillion in the last four months) and government spending greater than 40% of GDP.  What’s the point of a debt ceiling again?  For now, it looks like congressional leaders are attempting to responsibly govern with a tentative deal reached on top-line spending for the coming fiscal year which eases the risk of a partial government shutdown come January 20th.  It is worth noting though that a bit of fiscal drag is set to take place relative to the past year.  So, while fiscal responsibility remains on never-ending sabbatical the level of runaway spending is finding some restraint.

  The event I’m most interested in comes later in the month with the release of the Treasury borrowing schedule announced on January 29th.  Consensus expects a number around $970 billion where a higher number and/or a heavier dose of long-dated issuance will likely pressure long-end interest rates higher and that would put pressure on all asset prices.  Recall it was the QRA announcement at the start of August that set-off the 10% correction in stocks into the end of October, and it was the QRA announcement at the end of October that halted the correction and set the stage for the Q4 rally.  With the amount of debt the Treasury has to roll over on an ongoing basis, the level and mix of Treasury issuance has become a very important variable for overall liquidity.

• Super Tuesday on March 5th will be a headline grabbing date but shouldn’t matter too much to investors so early in the election calendar.  The main event will come on March 20th with the Fed meeting and the expectations that this is the earliest date for a possible rate cut.  It was tamer than expected inflation readings in mid-November and growing momentum of a Fed pivot that gave legs to the Q4 rally.  Wouldn’t it be poetic if the first cut also marked the peak in asset prices?  Look back at past Fed cutting cycles – they typically do not coincide with good things happening.  Sure, we could very well get the extremely illusive soft landing (and let’s hope that’s the way it plays out), but don’t ignore the probabilities on this one – they are not on your side.

• Not much to speak of in April or May but come June we have more Fed where market expectations are gravitating towards the Fed ending Quantitative Tightening as early as its June 12th meeting.  Estimates put the balance sheet floor at $7 trillion for the Fed given the size of the economy and financial system liquidity needs (for perspective the Fed’s balance sheet was at $4 trillion in January 2020 and peaked at around $9 trillion in April 2022).  The question for investors is what happens to the U.S. dollar if the Fed is both cutting rates and stops the unwind of its balance sheet – do RoW (Rest of World) assets finally get their day in the sun and outperform U.S. markets?  Mean revision would suggest it’s been a long-time coming, but only time will tell.

• In mid-July we have the Republican National Convention and the Democratic National Convention in August.  By this time the U.S. presidential election will be taking a more prominent role in capital markets.  The labor market will be a key thing to watch as it could very likely determine which way the wind blows in key swing states (Pennsylvania, Michigan, Wisconsin, North Carolina, and Georgia).  A rising unemployment rate will be trouble for President Biden who already is contending with very weak approval rates and that’s with the unemployment rate at historically low levels. 

• The BRICS summit is expected to be held in October in Kazan, Russia.  This will be the first summit with its expanded membership (Saudi Arabia, UAE, Iran, Argentina, Egypt, Ethiopia joined Brazil Russia, India, China, South Africa) and given the relative size of the global population, resource production, and GDP contribution to the world – the policies and objectives coming out of these gathers should garner increased attention.

• November 5th, U.S. citizens go to the polls.  Given how closely the last couple of elections have gone it’s likely there won’t be a clear front-runner in advance of the actual vote count.  It’s unlikely that markets will be strong going into the election as markets hate uncertainty and that is exactly what this election brings.

As for the upcoming week, the most important data point will be the inflation data on Thursday where the headline might tick up a bit but core CPI surprises to the downside.  Lower than expected inflation prints will be a relief to markets as it further cements a hawkish Fed is done and lowers the bar for rate hikes.   

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