“An economic ‘soft landing’ appears to be in the cards.”
The U.S. stock market’s year-end rally looks intact.
Lately I have been focused on equity hedge-fund performance and the necessity of hedge-fund managers to preserve and enhance returns ahead of their Dec. 31 incentive fee calculation dates. Funds that haven’t yet closed their books are on a “beta chase” in order to preserve performance bonuses.
Meanwhile, small-cap stocks are staging upside breakouts from multi-month bases during a seasonally positive period for the group. Further progress will confirm the bullish prognosis for these stocks, which could spark a FOMO stampede.
In addition, bitcoin
is a real-time proxy for financial system liquidity and it’s still rising, indicating strong market “animal spirit” activity. Even though I am a cryptocurrency skeptic, bitcoin may have more room to rally. Jurrien Timmer at Fidelity Investments has a fair-value estimate for bitcoin, and bitcoin prices are moving into that range.
In short, the underpinnings of the Santa Claus rally look solid.
The challenges of 2024
Looking to the new year, investors and traders are hearing calls to take profits in response to the strong equity rally from the October low. Yet keep in mind that the latest BoA Global Manager Survey doesn’t show the fingerprints of a major market top. While the risk levels of global institutions are normalizing, readings are not a crowded long and equity weights can rise much further before they reach a crowded long condition, which would be contrarian bearish.
Here is the big picture from a macro perspective. The U.S. market is discounting U.S. Federal Reserve rate cuts expected in the first quarter of 2024. Both “recessionistas” and bears have pushed back against the bullish Fed rate-cut narrative on the basis that cuts will only occur in response to slower economic growth and a possible recession. But numerous Fed speakers have underlined the message the Fed can cut rates if inflation were to fall.
An economic “soft landing” appears to be in the cards. The Atlanta Fed’s GDPNow nowcast of fourth-quarter 2023 GDP growth is 2.8%, which is nowhere near recession territory.
My sunny outlook doesn’t come without some risks. For instance, FedEx’s
most recent earnings report contained a recession warning: “U.S. package volume was down 3.5% in the November quarter, on a down 15.1% year-ago comp. In other words, the two-year volume trend is deeply negative, and worse than last quarter. So much for improving box demand…”
In addition, the stock market has been supported by strong financial liquidity. One key announcement to watch is the Quarterly Refunding Announcement (QRA) in late January, in which the U.S. Treasury announces its planned issuance. Despite the ballooning federal deficit and strong financing requirements, the Treasury has been issuing far more bills than coupon-bearing paper. The less-than-expected coupon supply supported bond prices, which in turn supported equity valuations.
Moreover, more T-Bill issuance has reduced the levels of reverse repos at the Fed, which has the effect of boosting liquidity to the banking system. The short-term fate of the Treasury and stock markets will hang in the balance at the next QRA.
Still, both my inner-investor and inner- trader are now bullishly positioned. My inner trader anticipates that he will start to take profits in early 2024, yet overall I’m short-term bullish on equities. The U.S. stock market may see some choppiness in the new year as hedge-fund flows dry up, and from calls for profit taking. But the macro outlook is constructive and investors should enjoy a decent year in 2024 for equity returns.
Cam Hui writes the investment blog Humble Student of the Markets, where this article first appeared. He is a former equity portfolio manager and sell-side analyst.