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Is it, finally, safe for investors to relax, near the end of a year that has been more rewarding than most had allowed themselves to expect? The market action and economic rhythms suggest the answer might be yes, for now. A steady run of data validating the preferred soft-landing story — with slower but still-healthy growth and persistent disinflation culminating Friday in a sturdy monthly jobs report showing 199,000 new jobs in November and moderating annual wage growth. The S & P 500 , which had consolidated with a low-volatility sideways slide for three weeks, nudged to a new 20-month high just above 4600, almost precisely a 20% year-to-date gain. This is, of course, just a few ticks above the late-July high-water mark, which preceded a trying three-month correction. Last week here , I argued some of the atmospherics resembled that July moment but that overall conditions differed in a way that favored a better outcome this time. .SPX YTD mountain S & P 500, YTD There’s a “No pain, no gain” crowd that will always argue that inflation can’t be beat without more damage to the real economy, that the Federal Reserve can’t look to ease policy pre-emptively, that the conditions under which it would cut rates by next spring as futures markets hint would not be supportive of continued equity-market strength. It’s fair to argue that victory cannot be assumed, there will be more “late-cycle” scares along the way and Fed Chair Jerome Powell next week might choose to convey more a “time out” than “game on” message on the easing talk. Still, and at the risk of seeming blasé about the hazards after a six-week, 12% ramp in the S & P 500, here is the case for why it might be OK to be more relaxed about the interplay of the economy, policy and markets. The Fed no longer believes it needs to bleed the patient in order to heal it. Just consider what Fed officials are on the record as believing about the current backdrop. Policy is already restrictive based on where short rates are relative to inflation. Further declines in inflation suggest trimming rates to keep from becoming incrementally tighter. Inflation is already lower now than the Fed in September projected it would be at year end. And the Fed’s own consensus projection doesn’t have them hitting the 2% inflation target until 2026, leaving the committee plenty of room and time to let current policy work. With inflation showing downside momentum – as long as it lasts – the Fed is done playing “bank shots,” by targeting other metrics such as job openings or services spending or gasoline prices or survey-based inflation expectations (all of which Powell deployed at one point or another in the thick of the inflation shock to undergird his assertive hawkishness). If inflation keeps trending the right way, officials won’t resist easing off the brake just because unemployment is still beneath 4%, say. Those of us who vividly remember the 1995 soft landing, helped by the Fed lightly pruning rates as the economy slowed after a year of fast hikes, will keep talking about how it was only possible because the Fed tolerated unemployment going lower (below 5.5% at the time) than it previously thought was possible without stoking inflation. The stock market doesn’t necessarily “need” the bond market’s most dovish rate-cut scenario to come true. Just because the S & P 500 is at 4600 and Federal-funds futures markets project high odds of several rate cuts next year, it doesn’t mean the former is reliant on the latter. Peak bond yields, peak Fed tightening, peak inflation, peak oil and the next Fed move being a cut rather than a hike could be enough for now. The reassuringly soft CPI report on Nov. 14 freed the market to treat good economic news as good news for stocks rather than a warning of tighter policy to come, and since that date consumer cyclicals, small-caps and industrials have whistled higher to outperform the S & P. Market handicapping of Fed moves several months out is largely a fast-shifting game of probabilities and “What if” hedging. No doubt the direction of surprise in the economy and rates could be to the downside, so speculators and buyers of insurance bet accordingly. Yet on Friday, after the jobs report, the prevailing probability of a first rate hike moved from March to May, end yet the S & P 500 gained 0.4%, bank shares were up 1% and 60% of all stocks were positive. It’s an experiment with a sample size of one, but gently pushes back against the idea that stocks require ever-advancing dovishness to work. The stock market has answered several of the biggest complaints that have hounded it all year. Yes, the largest seven stocks in the universe generated more than 80% of the upside in the S & P 500 this year, an extreme winner-take-most dynamic that most disdained and many feared. Yet the equal-weight S & P 500 has found its footing and is now sitting on an 8.2% total return year to date, a perfectly respectable showing approximating the long-term average. Granted, as this chart from Bank of America shows, an unusually large number of stocks are more than 10% below their all-time high, reflecting the earnings recession just past and late-cycle mindset still prevailing. A sliver lining here, though: Those green circles mark major market peaks from past cycles. Most occurred when market breadth was far stronger than it has been this year. The lone and fearsome exception, of course, is the March 2000 climactic top, which happened after the S & P 500 had compounded at 25% for five years, twice the pace of the current five-year trailing return. Resilient earnings FactSet’s John Butters noted in the past week that aggregating all the bottom-up analyst stock-price targets computes to an implied S & P 500 target of 5068, which would be up almost exactly 10% from here. The reflex reaction is to assume Wall Street stock pickers are congenitally over-optimistic about their companies’ prospects. Yet — just relax — in seven of the past 12 years, the S & P 500 went on to surpass this year-ahead analyst composite target. It’s pretty popular to cast doubt on the achievability of the consensus 11.8% forecast S & P 500 earnings growth for 2024. The first answer is, year-ahead projections almost always get revised lower as the year gets underway, and yet stocks are up more years than not. Then there is the concentrated and idiosyncratic makeup of the largest expected profit gainers. The Big Six growth stocks at the top of the index together are slated to kick in a fifth or so of net earnings growth next year. And then there are Merck and Pfizer, which together had $15 billion in extraordinary charges earlier this year which presumably won’t repeat. A quick look at the typical big bank or retailer or auto company shows anticipated declines or scant growth. Scott Chronert, chief U.S. equity strategist at Citi, has been detailing an earnings-resilience theme for months, arguing that big U.S. companies are less cyclical than in the past and should be able top produce better results even as he expects recession risk will haunt the economy all next year. He sums up his hopeful but nuanced take on 2024: “An eventual Fed policy shift influences our view but does not drive it. A broadening beyond 2023’s growth leadership is necessary for further S & P 500 gains. That said, increased volatility should be expected, and investors should be prepared to buy into pullbacks.” This states the setup reasonably well – less an up-and-away market than one that has earned itself a greater benefit of the doubt for dip buyers. There’s no denying that the market has used up several of the advantages from six weeks ago. Then the market was deeply oversold, sentiment was putrid, bond yields were way overstreched to the upside and due to retrace and seasonal tailwinds were just kicking up. Now, after a 12% move, stocks are mildly overbought, 10-year Treasury yields have fallen from 5% to 4.1% and just bounced Friday to 4.23%, oil dropped from $85 to $69 in a blink before also firming late last week. Investor positioning and sentiment are more elevated, though not yet at worrisome extremes. And the CBOE S & P 500 Volatility Index has ebbed toward a four-year low of 12.5 — befitting a calm, sturdy market in the thick of year-end-cheer mode, even if this leaves it open to seeming a bit too relaxed as a new year gets rolling.
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