/ December 18 / Weekly Preview
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Monday:
N/A
Tuesday:
Building Permits Prel. (1.48M exp.)
Wednesday:
N/A
Thursday:
GDP Growth Rate QoQ Final Q3 (5.2% exp.)
Initial Jobless Claims (223K exp.)
Friday:
Core PCE Price Index MoM NOV (0.2% exp.)
Durable Goods Orders MoM NOV (1.8% exp.)
Personal Income MoM NOV (0.3% exp.)
Personal Spending MoM NOV (0.2% exp.)
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Monday:
N/A
Tuesday:
FedEx FDX
Accenture ACN
FactSet FDS
Wednesday:
BlackBerry BB
General Mills GIS
Thursday:
Nike NKE
Paychex PAYX
CarMax KMX
Friday:
N/A
Dovish Fed Re-Ignites Animal Spirits
Last week, investors were surprised by the dovish tone that came out of the FOMC’s Interest Rate Decision meeting. With markets overbought and extended on all measures to start the week, we were expecting Jerome Powell to temper bullish enthusiasm at his press conference. That is not at all how events transpired. Instead, this note from Goldman Sachs sums up the meeting’s result:
“Today’s press conference was an endorsement of the Waller view that inflation is moving lower and that the Fed can pivot to a less restrictive policy stance. There was no change to the median neutral rate still of 2.5% – perhaps one thing to call out is by 2026 they are still above that at 2.9% – other years have come down because starting place is 25bps lower. Forward guidance was watered down: instead of ‘extent of policy firming’ we got ‘extent of ANY policy firming’. *POWELL: ADDED ‘ANY’ AS ACKNOWLEDGEMENT OF AT OR NEAR PEAK RATE.“
Even bulls were surprised that the Fed has effectively announced a “pivot”. Powell acknowledged that the Fed remains concerned that the lag effects of the sharp rate increases have yet to impact the economy fully. As a consequence, several premature rate cuts are on the table, in order to avoid a recession.
Stocks surged, bond yields tumbled, volatility and bears were crushed and the US Dollar tanked as a direct result.It does seem like the Santa Rally is off to a good start! Technically, SPY has exceeded our year-end target of $467 and is headed toward all-time highs ($477, +1.63%). Support can be identified near the recent consolidation, at the R3 level ($454, -3.26%) - note that we have used an adjusted chart for this, with a $470 Price Target and 7% CAGR.
SPY Analysis
The MACD Signal has turned bullish, after a brief and shallow period of weakness; upside remains limited, as the crossover has occurred from a very high reading;
The FOMC’s December meeting included an updated view of economic and rate projections (SEP). The Fed’s official median estimate is now for THREE 25bps rate cuts in 2024. One participant sees rates falling 1.25% by the end of next year. These projections are much more dovish than the market expected. Nick Timiraos of the Wall Street Journal sums up the change in tone in a recent tweet:
Does the Fed know something we don’t?
In the span of just 2 weeks, the change is spectacular, indeed! But what exactly drove the shift in policy language? And, more importantly, does the Fed know something we don’t?
We’ll need to look at their decision support tool more closely, namely projections and assumptions for monetary policy. According to the FOMC, economic growth is expected to slow sharply in 2024, justifying a drop in the Federal Funds Rate of 0.80 basis points.
Long story short, it seems that the Fed has declared the fight against inflation as won (or “Mission Accomplished”, as internet memes have circulated). Historically, however, more relaxed financial conditions (lower yields and higher stock prices) are associated with higher inflation, not lower. As conditions have loosened lately, we would have expected Jerome Powell to remain decidedly hawkish. However, that was not the case.
Technicals seem to favor the bulls as well. Some analysts correctly point out the formation of an important pattern called a “cup and handle” on the S&P 500:
“The pattern was first described by William J. O’Neil in his 1988 classic book on technical analysis, How to Make Money in Stocks. A cup and handle price pattern on a security’s price chart is a technical indicator that resembles a cup with a handle, where the cup is in the shape of a ‘u’ and the handle has a slight downward drift. The cup and handle pattern is considered a bullish signal, with the right-hand side of the pattern typically experiencing lower trading volume. The pattern’s formation may be as short as seven weeks or as long as 65 weeks.” - Investopedia
What Sectors and Factors could Benefit in 2024?
The market’s pricing suggests that we won’t get a recession in 2024 (a recession has never been the economic outcome with major stock market indices at all-time-highs). The latest data suggests our optimistic scenario is in the books for next year, with a SPY price target of $508 and around 8.2% upside (researched here).
Goldman Sachs has just issued a new Price Target for the S&P500 which basically confirms our optimistic outlook:
If we are to assume the market will do well next year, let’s look at which sectors and factors could benefit the most, under the assumption that the Fed will indeed pivot, and no recession occurs.
The first candidate for a rotation are small caps (IWM ETF). Small caps exhibit twice the upside potential of S&P 500 companies (around 16% on average), since these stocks have badly under-performed in 2023. A valuation penalty has been placed on smaller companies, only on the basis of market capitalization. Once this valuation gap closes, we could see IWM far outperform SPY and QQQ next year.
Another obvious candidate for a rotation are defensive sectors, which are priced relative to interest rates since they are preferred by investors due to their dividend payments: Utilities (XLU), Staples (XLP) and Real Estate (XLRE). Combined, these sectors have moved more or less in line with the 10-year treasury (IEI ETF). As yields regress, we expect these sectors to follow suit and realize significant upside.
Lastly, Tech (XLK) should also be a net beneficiary, especially the long duration companies (read: not profitable, high growth). Out of all major investment themes, Technology maintains the highest expected growth rates in a disinflation environment. Our Millennium Vision strategy can be a good place to start researching these high-risk / high-reward propositions.
And of course, we need to mention long duration treasuries as well (TLT), an asset class that offers a combined total return upside greater than SPY in our opinion.
Our Trading Strategy
With markets extremely exuberant, overbought and optimistic, we need to keep our enthusiasm in check for now. This is not the time to initiate new long positions. A healthy correction would resolve some of the short-term technical issues and allow for a better opportunity to deploy capital. In the interim, we’ve taken profits on positions which have enjoyed a decent run-up and gotten a bit defensive with our equity exposure.
We do need to recognize the bullish backdrop we’re trading in and react accordingly. Therefore, we don’t want to get “too” defensive just yet, as the market has done nothing “wrong”. Re-balancing is the name of the game for now, and we’ll be looking for more and more opportunities to rotate from 2023’s winners to next year’s probable winners.
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