The stock market hit the accelerator on Tuesday, with the S&P 500 (SPY) racing up by roughly 10% within just two weeks, a feat that typically takes a full year. This sudden surge led financial analysts to attribute it to the morning’s CPI report. However, a closer look at the actual October CPI report reveals a mixed bag of results. While used car prices are on the decline, services inflation remains hot, ticking along at a rate of 5.5% annually, with restaurant prices also continuing to climb at 5.4% annually.
What truly fueled this bullish sprint in the stock market is the much-discussed exit of the Fed from its rate-hiking spree, a development that has been widely discussed among journalists with close ties to the central bank. While some may argue in favor of further hikes, whispers from Fed insiders hint that additional rate increases are highly improbable.
“The October payroll report and inflation report strongly suggest the Fed’s last rate rise was in July. The big debate at the next Fed meeting is shaping up to be over whether and how to modify the postmeeting statement to reflect the obvious: the central bank is on hold.”
– Wall Street Journal reporter Nick Timiraos, via Twitter (X) on November 12.
Whispers & Waves in the Market
One of the major voices in this speculation is Nick Timiraos, the chief economics correspondent at the Wall Street Journal, who’s widely respected for his close rapport with the Fed. His tweet and subsequent article made a significant splash, triggering a seismic shift in Fed funds futures and stocks, sweeping away billions of dollars in bets on further hikes within a matter of hours.
However, this revelation has stirred a different kind of storm in the financial market, with traders now heavily banking on deep cuts to the Fed funds rate. This wave of optimism may be overly ambitious, given the inconclusive nature of the inflation data. Current CME data indicates that the market is anticipating four rate cuts by the end of 2024, with the first scheduled as early as March.
Divergent Markets: A Reality Check or Folly?
While the market uproar seems fervent, the reality is that the recent market surge was largely mechanistic in nature. According to historical trends, interest rate fluctuations should ideally cause a corresponding 1% shift in stock values. Yet, despite the Fed’s 22 rate increases, stock multiples have hardly flinched, indicating a significant divergence.
This scenario brings to light the historical pattern of stock rallies following a Fed pause. With remarkable consistency, such pauses have been closely followed by late-cycle stock upswings ranging from 10-20%, shedding light on the intricate relationship between the Fed’s policies and market dynamics.
The lurking concern, however, lies in the job market, where leading indicators underscore subtle hints of an impending slowdown in hiring. The ominous rise in continuing jobless claims and the projection of an unemployment rate above 5% within a year paint a bleak picture, casting a shadow on the optimism surrounding the Fed’s policy shifts.
Eye on Realities: Future Outlook & Investment Mantra
Amidst the euphoria, it’s crucial to place stock valuations within a broader historical context. With valuations perched at record highs, underpinned by unprecedentedly low interest rates and employment figures, any disturbance in this equilibrium could disrupt the current investment landscape.
The emerging question is whether the current stock valuations, buoyed by government policies, are sustainable in the long run. The looming specter of surging unemployment and stubborn inflation prompts a re-evaluation of the current investment ethos, underscored by the importance of historical context in driving informed investment decisions.
As the S&P 500 stands at approximately 21x peak earnings, venturing into uncharted territory, echoes of historical investment trends beckon attention. The critical pointer is not to be swayed by the allure of soaring valuations but to uphold a cautious stance, mindful of historical precedents and overarching market dynamics.