Fed Policy: Long and Variable Lags
In early June, an examination of the stock performance relative to bonds shed some light on the soft versus hard landing question. At the time, the stock/bond ratio was favoring the soft-landing scenario, and considering the long and variable lags of Fed policy, it’s prudent to revisit this question as we gear up for 2024.
Human Beings and Economic Fear
If market participants anticipate a deep recession, severe corporate earnings decline, and significant job losses, they would likely believe in a more aggressive interest rate cut by the Fed. Under this scenario, stocks could lose their appeal as earnings expectations decline, while bonds would receive a boost from the anticipated interest rate cuts.
Therefore, the following analysis aims to assess the attractiveness of major equity exchange-traded funds against the significant bond options, considering the unfolding economic scenarios.
Before The 2001 Recession
In March 2001, the U.S. economy entered a recession, confirming investor anticipation of a hard landing. The S&P 500 Index relative to the price of a 10-year U.S. Treasury bond displayed investors’ diminishing conviction to own stocks and an increasing desire to own defensive U.S. Treasury bonds.
2008: Risk-Off Well Before Lehman
Before the Lehman Brothers’ bankruptcy in September 2008, the stock/bond ratio had already entered a bearish trend, indicative of the looming challenges in the U.S. economy. This trend signaled a strong risk-off sentiment well before one of the darkest days in the nation’s economic history.
How Does The Same Chart Look Today?
As of mid-December 2023, the stock/bond ratio continues to favor the soft-landing/risk-on scenario, mirroring the June assessment. This perspective indicates limited economic fear, as highlighted in the presented images.
The contrast between the 2023 and 2008 charts is stark. The 2023 chart signals a bullish sentiment, while back in 2008, the indicators were firmly bearish. This suggests that the current market conditions do not support a significant shift to bonds from stocks, as the data indicates.
Post-CPI Moves Were Insightful
Examining the market’s reaction following the CPI data release and the subsequent dovish interest rate forecasts from the Fed provides valuable insights into the changing economic landscape.