The Market Scrooges Got it All Wrong

Remember all those dire warnings about our bleak economic future? We supposedly faced a perfect storm of rampant inflation, a market crash, rising unemployment, and a sharp recession.

Case in point: Larry Summers, former U.S. Treasury Secretary, predicted last year that to curb inflation, the U.S. needed an unemployment rate of 5% for five years or 10% for one year.

Summers also served as Director of the White House National Economic Council, as President of Harvard University, and as the Chief Economist of the World Bank. So he must be a smart guy, right? The economic establishment mostly fell in line with his pessimistic outlook.

This holiday season, here are the facts: the consumer price index has fallen to 3.1%; the S&P 500 has surged about 23% year to date; unemployment has fallen to a 50-year low of 3.7%; and gross domestic product in the third quarter grew by 4.9%.

The market Scrooges got it all wrong. Welcome to this year’s Christmas miracle: an economic soft landing.

The Federal Reserve gifted investors during last week’s policy-making Federal Open Market Committee (FOMC) meeting. Following six weeks of consecutive gains, the festive spirit persisted on Wall Street last week, propelling stocks into their seventh week of positive returns.

In the vanguard of the rally have been the mega-cap technology stocks, but a bullish factor is the rising New York Stock Exchange Advance/Decline line (NYAD), which indicates a more diversified market leadership.

In recent days, interest rate-sensitive segments have outperformed, e.g. small-cap stocks, the real estate sector, and high-quality dividend stocks. This dynamic, whereby the laggards become the leaders, should continue for the rest of 2023 and into the new year.

The star on the tree last week was the result of the FOMC’s two-day meeting. The Fed confirmed a pause in rate hikes and pointed to potential rate cuts in 2024.

The Dow Jones Industrial Average last week hit an all-time high, and both the S&P 500 and NASDAQ surpassed their 52-week highs (see table).

As 2023 draws to a close, the S&P 500 is approaching its all-time high reached in December 2021. The major catalyst for the rally is the prospect of looser monetary policy.

The “dot plot” unveiled at the December FOMC meeting conveyed the possibility of three rate cuts in 2024. Market sentiment has surpassed the Fed’s forecast, anticipating up to six rate cuts in 2024. In my view, the expectation for six rate cuts is probably too optimistic, but the fact is, we’ve reached peak rates and a pivot is on the way.

At his post-announcement press conference last week, Fed Chair Jerome Powell depicted a more balanced labor market, with increased labor supply and eased demand. Powell emphasized that the Fed could start cutting rates even if inflation hovers around 2.5%, which would exceed the central bank’s 2% target.

The decline of Treasury yields is supporting bond returns, with the Bloomberg U.S. Corporate (investment grade) index higher by about 11% since mid-October.

As the new year approaches, you should reassess your portfolio. King Cash is set to relinquish its throne in 2024. The $6 trillion flowing into CDs and money-market funds in 2023 will find new directions amid falling rates.

As market leadership broadens, underperforming asset classes are on track to continue their upward momentum next year. Opportunities will emerge in cyclical sectors, small- and mid-cap stocks, and investment-grade bonds.

On Monday, the main U.S. stock market indices closed mostly higher as follows:

  • DJIA: +0.00%
  • S&P 500: +0.45%
  • NASDAQ: +0.61%
  • Russell 2000: -0.14%

The S&P 500 is now 1.2% away from its all-time closing high that was reached in January 2022.

The week ahead…

This week is the lead up to Christmas, but nonetheless, the schedule is crammed full of market-moving economic reports. The highlights:

Home builder confidence index (Monday); housing starts, building permits (Tuesday); existing home sales (Wednesday); initial jobless claims, Philadelphia Fed manufacturing survey, U.S. leading economic indicators (Thursday); durable-goods orders, personal income and spending, personal consumption expenditures index (PCE), new home sales, consumer sentiment (Friday).

The biggest news will be the PCE, for November. The PCE is the Fed’s preferred inflation measure because it covers a much broader range of spending than the CPI, which only reflects out-of-pocket spending. The consensus expectation is that the latest PCE data will show a further cooling of inflation.

WATCH THIS VIDEO: Navigating The Transition from 2023 to 2024

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John Persinos is the editorial director of Investing Daily.

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