Long-time readers know that I am a card-carrying member of The-glass-is-at-least-half-full club. As such, it shouldn't surprise anyone that I have maintained a fairly upbeat view throughout this year. On the economy. On earnings. On the stock market. On the consumer. And, of course, on inflation.
On that last topic, I will admit that the concept of high inflation being "transitory" took a little longer than I expected. While it was ugly there for a while, it does appear that inflation is now trending lower and the risks of inflation "expectations" becoming "entrenched" in consumers collective psyches has fallen. As expected, once the supply chain problems were sorted, once the "revenge" travel was completed, once the pent-up demand for "stuff" and experiences dwindled, and once the trillions of dollars dropped into our checking accounts during the pandemic got spent, things calmed down on the inflation front.
No, the Fed is not yet able to declare victory in its battle against rising prices. But there can be no denying that inflation is indeed heading in the right direction. Which apparently allowed Mr. Jerome Powell to offer up some rather dovish comments this week. Comments that even took optimists like me by surprise.
In my last piece, I noted that words mattered. Especially those from the Fed Chair. So, from my seat, Powell's words on Wednesday were quite telling. Gone was the table pounding about "higher for longer." Gone were the projections of the economic "pain" that was sure to result from the Fed's inflation fight. Gone was the talk about additional rate hikes. And gone was the pushback on the market's expectations for rate cuts in 2024.
Instead, and again, this is merely my $0.02 on the subject, Powell let it be known that the Fed "pivot" is here (for real this time) and the landing will be soft. So, as far as the markets are concerned, Goldilocks is in the house!
More specifically, investors were treated this week to a "dot plot" from the FOMC members which projects not one, not two, but count them, three rate cuts next year. Which, if you might recall, is right in line with what the markets have been expecting for some time now. Jay Powell even went so far as to say his merry band of central bankers spent some time at this week's meeting discussing the timing of rate cuts. So, I guess the committee is doing more than just thinking about thinking about changing their policy.
Flipping The Switch
The key is it appears the Fed started to flip the switch on monetary policy this week, which took the markets by surprise. In a good way, of course. Yields plunged. Stock and bond prices soared. And this time, it's more than the Magnificent Seven stocks leading the charge.
Don't look now fans, but the heretofore beleaguered small and midcap stocks are more than along for the ride here. If my calculator is working properly, it looks like the IWM (iShares Russell 2000 ETF) has more than doubled the return of both the S&P 500 (using SPY as a proxy) and the much-loved NASDAQ 100 (QQQ) over the last month. And the KRE (SPDR Regional Bank ETF), which has taken the brunt of the bears' ire this year and is still down YTD, has surged ~36% since the beginning of November. Not too shabby.
The thinking among traders is that interest rates moving down will remove the piano from the backs of small and midcap companies. Since these companies tend to have more debt, they stand to benefit from a lower rate environment. And since the spread between the returns of megacap tech and small/midcaps had become monstrous, traders appear to be doing a little mean reversion work right now.
The bulls are also busy telling anyone who will listen that the participation by the market's "troops" means the advance is broadening out. Something that technical analysts say is positive, and a precursor of good things to come.
Then there is the history showing that stocks tend to advance nicely once the Fed stops hiking rates. And, of course, our heroes in horns also remind us that seasonality is quite favorable for at least a couple months. As such, it looks like it just might be a happy holiday season on Wall Street once again.
On the Other Side of the Field
Of course, our furry friends on the opposite sideline can be heard complaining about overbought conditions (Goldman says that nearly one-third of the S&P constituents have an RSI over 70) and extremely upbeat sentiment. The bears argue that the six-week rally has gone too far too fast, effectively discounting the Fed's pivot and the soft landing. They contend that deflation is setting in, and the economy will slow faster than expected. And that falling interest rates can't stay good news for too much longer. Oh, and lest we forget, the glass-is-half-empty crowd reminds us that QT continues unabated and the effects of the Fed's hiking campaign have yet to be felt.
In addition, the bears opine that the Fed isn't likely to go quietly or just start cutting rates willy nilly. In fact, just this morning, NY Fed Pres John Williams pushed back on the idea of cutting rates, saying that any discussion of cuts in March are premature.
So, how does one reconcile the teams' arguments these days? After all, the bears make some decent points. And with stocks now very overbought and exuberance high, a nasty day or three would seem appropriate.
Personally, I like to keep things simple at times like these. So here's my take. First, understand that the ride is not going to be smooth. Any move higher from here will almost certainly experience bouts of selling, this is just the way the game is played. But from a big-picture standpoint, earnings continue to rise, are at record highs, and are expected to increase double digits next year - again, to record highs. So, in my feeble brain, this means that stocks could very well follow suit.
Sure, this is an extremely simplistic view of the situation. And yes, Wall Street analysts and their earnings estimates aren't exactly known for their accuracy. But for now at least, I'm keeping my seat on the bull train (as well as an eye on the exit sign. You know, just in case!).
Here's wishing everyone a joyous holiday season!
Thought for the Day:
An error is not a mistake until one fails to correct it. -Anonymous
Wishing you green screens and all the best for a great day,
David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research, a Registered Investment Advisor
At the time of publication, Mr. Moenning held long positions in the following securities mentioned: SPY, QQQ, IWM - Note that positions may change at any time.
NOT INDIVIDUAL INVESTMENT ADVICE. IMPORTANT FURTHER DISCLOSURES