December 4, 2023
The rotation out of mega-cap Tech and into YTD underperformers will likely continue for the next couple of weeks. In index terms, this would favor the Russell 2000 (RTY) over the Nasdaq 100 (NDX). Mega-cap Tech remains the most crowded long position and the pain trade hasn’t yet fully kicked in. Beneficiaries should continue to be segments of the market that are still down for the year – think banks, regional banks and biotech. Eventually the momentum reversal will exhaust itself. Using history as a guide, we’d guess the trade could run out of steam by the middle of the month.
Consensus has embraced the idea that the Fed has concluded its hiking cycle, but there’s plenty of uncertainty around the timing of the first rate cut and the rationale. The soft-landing camp expects the Fed to ease once core inflation settles back toward the Fed’s 2% target. The other school of thought has the Fed cutting rates in response to a recession. Market based probability for the first cut to occur in March now sits at 51%. This presents a problem for the soft-landing camp given the unlikely potential for core inflation to be on a path to 2% by then. Recent growth data doesn’t seem to support the idea of an imminent recession either. This may mean that the market-based probability for the first rate is just too aggressive and needs to reset. This Friday’s Jobs Report and next week’s CPI print should offer more clues, but markets will likely wait for the Fed’s updated dot plot on 12/13 to reprice in either direction. The current median dot implies a 5.125% terminal Fed Funds rate. A material decline in the median dot could result in rising expectations for a March rate cut, while no change could result in higher bond yields and lower stock prices.
The 8% November rally in the S&P 500 (SPX) followed a sharp decline in bond yields as markets priced in expectations that the Fed has concluded its hiking cycle. The end of a Fed hiking cycle has had bullish implications for equities in recent history. In the four episodes that occurred from 1995-2019, the SPX returned an average of +16.9% in the 12 months following the last rate hike. If the Fed concluded its hiking cycle at the July meeting and history repeats itself, there may be further upside for equity markets. Especially when you consider that the SPX is only up +0.6% from the July rate hike through Friday’s close.