Stocks Rally Upon Anticipation of the Big Ease

Before the most highly capitalized Magnificent Seven stocks, or Mag 7, came to dominate markets in 2023, they might have been more appropriately titled the Lag 7 as they led the Bear market lower in 2022. At the Bear market lows the average Lag 7 stock was down by 34%, with Meta and Nvidia down about 60% and Tesla losing over 70% due to Central Banks raising interest rates far higher than most expected. In 2023 the Lag 7 became the Mag 7 on the back of Nvidia’s Artificial Intelligence (AI) surprise jump in orders. Even though the Fed never wavered in its messaging to investors through November 2023 that rate hikes were more likely than cuts, the Mag 7 held firm, thanks to AI. The broader markets outside of large capitalization growth stocks remained in basing patterns in 2023, with many sectors reaching multi-year lows as late as Halloween. As the markets rebounded into mid-December, Fed Chair Powell poured gasoline onto the stock market December 13th, declaring that several rate cuts in 2024 were coming. Suddenly the broad small and mid-cap sector laggards jumped to the leader board. The unrelenting 9-week rally into year-end without more than a one-day pullback or more than a one percent decline helped set records going back to 1985. The reason for investor optimism over a “Big Ease” in the Fed’s interest rate policy is crystal clear when looking around the world where all Central Banks have accomplished most of their goals in bringing inflation down substantially toward the 2% target (see charts below). With Fed controlled short-term rates clearly in restrictive territory, money managers are rapidly pricing in the Big Ease for 2024. With the odds of a Bear market before the November elections in either Bonds or stocks close to zero, the Fed put option is in place. The Fed Put is the belief that with inflation almost defeated, the Fed will intervene with rate cuts even faster should stocks and the economy begin to falter.

Even the global (US based) companies not weighted to the Mag 7 rode the news of the Big Ease of Fed rate cuts to new record highs in the final week of the year. Blue chip indices in the US, Mexico, Europe and Japan all edged into new record high territory by year end on the new consensus that central banks had to start cutting rates in 2024. Lower interest rates mean higher multiples can be applied to stock prices.

While small and mid-cap value and healthcare caught a nice bid over the final 9 weeks of the year, they have a long way – and some actual rate cuts – before they join growth stocks with new highs. Mag 7 stocks are heavily bid by most investors and can still appreciate further, but the lagging sectors have low valuation multiples and more opportunity as yields decline in a no recession environment. Small/mid-cap, healthcare, consumer staples, financials (banks/insurance) and other interest rate sensitive sectors should benefit in an environment where yields are forecast to be sideways to lower all year.

Thanks to Uncle Sam’s free money gravy train while there was no recession over the past few years, the positive cash flow of corporate America is surging. Normally we expect record Government handouts only during high unemployment economic contractions, but Covid provided the perfect timing to pass 4 years worth of stimulus. The overstimulated consumption and free money cycle is causing net cash flows to rise as if they are coming out of a recession that never was. 

Strong cash flows, more than profits, are essential for liquidity and reacting quickly to opportunities and challenges. The Governments non-emergency free money and artificially suppressed borrowing rates has raised credit quality and lessened both business and consumer debt service burdens. With a full employment economy and the continued skilled worker shortage, profit margins and stock prices remain in a favorable position for 2024. The fact that it’s an election year with a backlog of Government stimulus scheduled to be handed out certainly helps garner reelection votes and provides an ongoing tailwind for equities.

The unprecedented run higher toward record highs for the past 9 weeks has left too much cash on the sidelines increasingly anxious for a dip to jump on board. Without more than a one day, one percent pullback since Halloween, traders began shorting the rallies into Thanksgiving. Then Fed Chair Powell announced in mid-December that 2024 rate cuts were likely for the first time. This triggered short covering and investors tiptoeing their cash into equities to Buy. Most are expecting a January pullback after the Santa Claus rally, but despite our own overbought chart below, we would not expect anything more than small single digit % decline into late January. With a typically Bullish election year in a tight labor market with even more new stimulus flooding in and falling interest rates, there is solid support for an upward biased stock market this year. Thus, the only risk we see is for some modest downside in prices after a series of peaks in early January and mid-February. Downside risk is 4 to 8% into late March before the next leg up in the Bull market resumes.

The daily charts and seasonals favor an SP 500 Index that finally reaches and possibly surpasses its record highs from 2 years ago. On or before January 12th we expect a small top that could hold until the end of January. Short term traders can hedge their longs at new highs, but investors should stay invested, using any correction into late January to add to longs and keep diversifying into small and mid-cap value while holding mega cap winners. This is a broad-based rally that should remain in an uptrend through late August.


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