On December 18, 2024, the Federal Reserve, in a move that surprised few, announced a quarter-point reduction in the Fed Funds rate. However, the accompanying guidance hinted at fewer rate cuts in the coming year than market participants had anticipated. Investors had hoped for a more dovish stance, particularly against a backdrop of stubborn inflation and a surprisingly resilient economy. Yet, the remarks from Fed Chair Jerome Powell were interpreted as bearish, signaling that persistent inflation—hovering above the Fed’s target—might prompt the central bank to hold off on further stimulus.
This paradoxical situation underscores a critical truth: a robust economy and a healthy labor market do not require additional monetary easing. The Fed’s mention of “policy uncertainty” related to former President Trump’s tax cuts, tariffs, and immigration policies suggests that the board is unlikely to resume rate cuts until there is a clear downward trend in inflation data. Indeed, inflation, which peaked at 2.6% six months ago, has stagnated, drifting sideways without signs of significant improvement. Investors may be surprised that year-over-year yields will trend lower over the next 4 months as higher monthly basis is removed from the monthy data.
The recent sell-off in equities serves as a stark reminder of the fragile equilibrium between monetary policy and market expectations. Yet, it is essential to note that the major indices experienced only a modest decline of 4 to 6%, classifying this as a typical correction. Historically, the S&P 500 sees two to three corrections of 5% or more annually, with one decline exceeding 10%. This year has already witnessed three corrections of 5%, one of which dipped into the double digits.
After the initial panic following the Fed’s comments, the core PCE inflation report released on December 20 helped restore some calm to the markets. The subsequent remarks from two Federal Reserve governors suggesting that the PCE report could justify further rate cuts in 2025 alleviated much of the anxiety that had gripped investors just days prior. Following this news, stocks rebounded sharply, recovering approximately 60% of the earlier decline.
Even as stocks sold off at the end of the day on the 20th on concerns about a potential government shutdown, Congress surprised analysts with a streamlined spending bill that passed swiftly, buoyed by a pledge from the President for a festive holiday season. This unexpected development after the market closed could provide a favorable tailwind for markets when they reopen on December 23.
At the recent peak of the S&P 500 on December 6, investor sentiment had reached euphoric levels, with surveys indicating extreme optimism. Such conditions often foreshadow corrective phases, particularly when money managers push their exposure to equities to the limit. This exuberance inserted an exclamation point upon the realization of the staggering rise in Elon Musk’s net worth, which has ballooned by $200 billion to a remarkable $500 billion since Trump’s election—a feat that underscores the volatility and speculation at play in today’s market.
Bitcoin continues to be both a Trump trade and digital gold rush in the early innings since being certified by regulators around the world. The world is competing to mine the ever dwindling 6% of mineable supply remaining of this pseudo currency.Early adopters of Bitcoin tend to adopt a long-term hold strategy, which may mitigate the intensity and duration of profit-taking episodes. Since the critical breakout above $70,000 we continue to maintain that the $80,000 to 90,000 bracket will serve as a concrete floor of support in the foreseeable future.
The recent correction, primarily among mega-cap stocks in the S&P 500 and Nasdaq, has been brief. It would not be surprising to see additional profit-taking in early January, as most analysts seem to believe, as investors lock in long-term gains. Nevertheless, our prevailing wisdom remains bullish, favoring a strategy of buying dips. Large-cap stocks are likely to continue outperforming their smaller counterparts until interest rates shift course and begin to trend downward. With inflation basis dropping off of the 12 month averages from late January until late April, the small and mid-cap cohort may finally be nearing another overdue leg higher.