Even the most ardent stock and bond bulls were caught off guard by the central bank’s decision to signal the end of its historic monetary-tightening campaign with a dovish 2024 pivot. In the aftermath, the Dow Jones Industrial Average and Nasdaq 100 surged to records, while bonds soared, credit boomed and risky assets around the world rallied.
The dramatic moves upended countless outlooks. JPMorgan Asset Management’s Philip Camporeale increased the equity allocation in his stock-bond portfolio to the highest in nearly two years after Powell’s speech. John Roe at $1.4 trillion Legal & General said he’s unwinding long duration bets on inflation-protected Treasuries and reconsidering his underweight exposure to stocks. And Spencer Hakimian of Tolou Capital Management said signs the Fed will start cutting rates as soon as the first quarter prompted him to wager on a steeper yield curve.
As investors weigh how to approach the new year, serious questions are being raised over how much juice markets have left, and whether both stocks and bonds can continue to rally in tandem in the months to come. Would the benevolent business cycle that equity traders are pricing in really warrant the roughly six quarter-point interest-rate cuts the bond market predicts, especially with inflation still above the Fed’s 2% target? On Friday, officials already began to push back, with New York Fed President John Williams calling talk of a March rate cut premature.
“The pivot will make us rethink our fundamental view — we’re still deciding how much,” said Roe, the head of multi-asset funds at Legal & General. “We were very surprised they’ve acted so early with inflation still above mandate consistent levels.”
A week of so many market superlatives will make anyone rethink their world view.
The S&P 500 notched its seventh straight week of gains Friday, the longest in six years, as it flirted with a record high. The Bloomberg US Treasury Total Return index was up 2% through Thursday, on track for the biggest weekly gain since March 2020. Elsewhere, credit spreads tumbled, global currencies surged versus the dollar and emerging-market assets soared post-Fed.
For market prognosticators, this is forcing them back to the drawing board.
Amid a tumble in the 10-year Treasury yield, JPMorgan Asset Management’s Priya Misra says she now expects the benchmark rate to fall to about 3% by then end of next year, scrapping her 3.5% target from earlier this week.
Piper Sandler’s Michael Kantrowitz, one of the most bearish equity forecasters on Wall Street, is also rethinking his outlook.
“A Fed pivot has clear bullish historical precedence,” Kantrowitz wrote in a note. “Thus, we believe that breadth in the market will continue to improve,” adding that “stocks can drift higher on the back of lower yields.”
Yet as more traders and strategists boost their forecasts for both stocks and bonds, some are already questioning just how wide-spread this rally can be.
“Both stocks and bonds have run pretty hard in a very short period of time, and I wouldn’t expect that to continue in a straight line,” said Dan Suzuki, deputy chief investment officer at Richard Bernstein Advisors.
What’s more, amid all the exuberance, there are signs that investor positioning is getting stretched.
Speculators in 10-year Treasury futures recently flipped from short to long, with bullish positioning reaching the highest since at least 2020, according to data from JPMorgan.
Meanwhile, discretionary investors’ exposure to stocks is hovering around levels last seen in 2021, according to Deutsche Bank.
And junk-bond exchange-traded funds have seen unprecedented inflows of more than $15 billion over the past six weeks, according to data compiled by Bloomberg.
“The market moved too far too fast. Powell’s aggressive reversal likely prompted capitulatory buying,” said Michael O’Rourke, chief market strategist at JonesTrading. “The market will be more prone to disappointments now that the wall of worry has been torn down.”
Equity investors appear unfazed. They’ve been piling into beaten down sectors of the market that are more sensitive to the economic cycle in recent days. This week small-caps stocks in the Russell 2000 jumped nearly 6% as real estate equities surged more than 5%.
“We have a growing economy, a strong consumer, low unemployment and the Fed is effectively off the board,” said Chris Zaccarelli, chief investment officer at Independent Advisor Alliance. “It’s about as bullish a setup as you can get.”
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Published: 16 Dec 2023, 06:28 AM IST