By Jasen Dahm, CPA, CFP®
In the final scene of the late ‘90s cult classic, Fight Club, the last words the main character utters to his love interest are, “You met me at a very strange time in my life.” Under conditions much like the mischief and mayhem that permeated the iconic film’s narrative, you’re meeting me at a very strange time in the markets as I take over the reins of our monthly update.
December 2023 would be best defined as a “risk on” trade. All the equity indices remained strong, extending the rally from November as Fed Chair Jerome Powell’s comments earlier in the month reaffirmed investor suspicion that rate hikes appear to be over for now and the Fed may be poised to make multiple cuts in 2024.
The Dow, S&P and Nasdaq ended the year on fire, seeing positive performance for nine straight weeks. The Dow led the way closing the period up over 6%, while the Nasdaq and S&P both returned nearly 5%. It’s important to note that the S&P hasn’t had a nine-week winning streak since January 2004. However, based on 2024’s first week of trading, that may be coming to an end.
If we look at the bigger picture, returns for the 2023 calendar year are even better. Coming off the heels of a dismal 2022, the Nasdaq led the way at over 43%, while the S&P closed the year up over 24% — less than 1% away from all-time highs. The Dow also reached new all-time highs in late December, closing up almost 14%.
What’s strange is all the equity growth happening while there is so much uncertainty and volatility in interest rates. It’s not a coincidence that equities soared in Q4 when rates over that time period declined dramatically in the 2-, 10-, and 30-year space. Most of the rate declines occurred in November, but the trend continued into December with the US AGG rising almost another 3%.
The very front end of the curve, where the Fed Funds currently sits at 5.5%, has and will likely remain consistent until the Fed actually starts cutting rates. However, as those anticipated rate cuts priced into the system, even 6- to 12-month Treasuries has fallen off. This means your short treasury and bank CD ladders are going to be less competitive with money market rates but that may not last.
The 10- and 30-year treasury yields experienced a massive short-term change, falling below 4% from highs of around 5% in early October. Yield curves are supposed to slope upward, but we’ve now been inverted for more than 18 months. The market is clearly betting on lower rates ahead.
Another anomaly in the market involves longer term rates, which are supposed to have low or negative correlation with equities. In 2023, the 10-year bond had an approximate 80% correlation with the S&P 500, compared to an 8% correlation over the previous 10 years!
It’s safe to say that rates were the headline story of last year, and the Fed may continue to be the tail that wags the dog in this cycle.
As we move forward into the new year, the U.S. economy continues to navigate complexities with a mix of resilience and caution. The messaging around Fed policy and how the market perceives its tone will continue to serve as a catalyst for markets. We’re still in the “bad news is good news” phase, meaning hotter economic data might be perceived as an indicator of continued inflation causing the Fed to be potentially more hawkish regarding rate cuts.
According to the CME’s Fed Rate Watch Tool, at year-end the marketplace is pricing in an 83.5% chance of a hold and a 16.5% chance of a rate cut.
Several asset managers have recently issued two sets of forecasts, complicating the economic outlook at present. JP Morgan is the biggest name bear right now, estimating a 12% decline in the S&P 500 by end of 2024. Oppenheimer is on the bullish side, calculating about 10% upside for the S&P 500 by end of 2024. Most other institutional asset managers are falling somewhere in between these two estimates. Consensus seems to reflect muted optimism for an economic soft landing, which would lead to the previously mentioned rate cut cycle beginning sometime in mid 2024. However, a top-end gain of 10% isn’t exactly a bold prediction. It suggests asset managers across the spectrum are also in a “wait and see” mode when it comes to key Fed and economic data.
While we all know the markets can be fickle, I don’t think we need to be afraid of what may come next. This 30-year view of the VIX, commonly dubbed the “fear” index, shows that “fear” has all but left the marketplace. Before it spiked by over 10% to open markets in 2024, we were approaching absolute levels near the lows of 2017 and 2007. We may enjoy a little calm. But don’t get too comfortable. If Fight Club taught us anything, it’s that complacency can lead to chaos, and mayhem is but a sleepless night away. Let’s all be careful out there.
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Jasen Dahm, CPA, CFP®, is Managing Director of TAG Invest, the investment program available to TAG Advisors. He consults financial advisors on asset management, tax planning, liquidity management, and advanced case design. His prior experience includes running an asset management program, accumulating and managing over $1.1 Billion.
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