January 2, 2024

The Federal Reserve’s (“Fed”) December dovish pivot signaled “all clear” for the markets as the FOMC begins to contemplate when to start cutting rates before any meaningful deterioration in the economy or the labor market.  Powell has seemingly abandoned his prior concerns about loosening financial conditions as the financial markets anticipate Fed easing in 2024.  Additionally, he now views the risk of doing too little equally with the risk of doing too much, a notable change in tone.  “Soft landing” is now the consensus view.  Given the progress on inflation to date, the Fed is certainly in a better position to pull it off compared to six or twelve months ago – or at least, limit any recession to a shallow one.

The latest economic data continue to support a “Goldilocks” view on the economy and inflation.  In the past two weeks, we saw housing growth rebound in November in response to lower mortgage rates, along with a jump in consumer confidence.  Jobless claims remain low, indicating the labor market remains stable.  And the November personal consumption expenditure (PCE) data showed resilient consumer spending and a further moderation in inflation, confirming the prior CPI and PPI readings. The symbiotic relationship between consumer spending and business hiring remains intact with no visibility of a shock or crisis to break this dynamic at the moment.  While consumer headwinds exist (slowing job/wage gains, diminishing savings, resumption of student loan payments, rising credit card balances/delinquencies, and tightening bank credit), lower gas prices, mortgage rates, and rising stocks offer some temporary reprieve. The Fed, however, needs to be careful that easing financial conditions doesn’t lead to a re-acceleration in the economy at the same time the labor market remains relatively tight.

Fourth quarter earnings per share estimates for the S&P 500 edged slightly lower, and 2024 earnings remain at risk in our view as growth and inflation moderate even further, potentially leading to disappointing revenue and margins.  Meanwhile, investor sentiment remains excessively bullish and likely on the verge of entering the “euphoria” zone.  The so-called “fear gauge” – the CBOE Volatility Index (VIX) – at less than 13 reflects an astounding amount of investor complacency despite rising geopolitical risks.  While stocks could continue to move higher in the very near-term, the set-up heading into 2024, especially compared to a year ago, is not a particularly favorable one.

We continue to see near term market headwinds, including:  (1) fully-valued stocks; (2) overly optimistic 2024 earnings per share estimates; (3) rising geopolitical tensions; (4) Presidential Cycle/election uncertainty; and (5) too much investor complacency.