The initial months of 2024 brought forth a stock market closely attuned to even the slightest indications of Federal Reserve action, endeavoring to anticipate the Fed's next move or lack thereof. January commenced with the expectation of six interest rate cuts by the Fed throughout the year, fueling a significant uptick in the stock market. However, by the close of the quarter, this anticipation had dwindled to three potential rate decreases, with the possibility of none in the first half of the year.

 

The Federal Reserve appears unhurried, a stance that appears acceptable given the relative strength of the economy. Our conjecture suggests that rather than swiftly reducing rates, the Fed is inclined towards a more gradual and prolonged approach. This strategy lays the foundation for a sustained market upturn in both equity and bond markets. Additionally, the Fed has strongly hinted that should economic conditions begin to deteriorate, rate cuts will be implemented more rapidly—a phenomenon known as the "Fed Put." For investors, this holds paramount significance. With an economy witnessing the ascent of earnings and profits, as depicted in Chart #1, navigating this landscape is of utmost importance.

CHART 1

Plus, you know that over the next few years we will be in an environment where interest rates will be falling.  Sounds great!  Put more money to work in the market – or classic “risk-on” approach.  On top of that, if you are wrong and profits and revenue begin to drop – the Fed has your back!  They will then just speed up the rate decreases.  If the market is “tired and lethargic” the Fed will just serve the market with a double  expresso to get you back on track!

It's nice to have the “Put,” but we don’t think the market will need it.  As we have stated that earnings, revenue, and margins are doing well on their own, interest rates will drop as inflation drops – and it will!

CHART 2

With the current Fed Funds rate at 5.25 – 5.50%, we all know the Fed would like to ultimately have a “real” interest rate (interest rate minus inflation) of around 2%.  So, if inflation does fall to 2%, then the Fed Funds rate should be around 4% - that’s over 1 ¼% lower than it is now!  So, that translates to 5 or 6 separate 0.25% interest rate reductions over the next 18 months.  Additional wind at their back will be the potential that the Fed will start slowing on its sell off of its massive balance sheet.  That’s slightly bullish – or maybe less bearish.

 

One should understand that the Fed has a history of missing the mark on their projections.  There are some “rumblings” that inflation may fall below 2% over the next 2 years.  The trend is definitely there.  See the CPI and PCED charts below.

CHART 3

CHART 4

If that sounds like “crazy talk,” the U.S. inflation was 1.81% in 2019 and 1.23% in 2020.  And do you remember what the Fed Fund rate was in 2020?  It was 0.25%!  Our predictions are for 2-3 rate reductions this year and 3 or more next year and 2-3 more in 2026.

For the stock market, our S&P 500 prediction of 5400 may be a little low.  So, we are raising it to 5500.  Wouldn’t be surprised to see it at 6000 in the next 12 months.

But what could go wrong (famous last words!)?  Well, I could list a dozen things, but at the top of the list is the high bullish consensus.  See the AAII Chart #5.  We are dangerously high and wouldn’t be surprised to see a 7-10% correction.  This may sound crazy, but little correction here would be better for a long and sustainable bull market.

CHART 5

The other concern is a possible oil disruption.  There are plenty of “hot spots” in the Middle East to start this – particularly the Red Sea of Yemen.  It could cause a global shock – but the U.S. would be insulated due to our independent energy status.

What I do like is that there is no asset or commodity bubble to burst.  Commodity prices are reasonable, real estate prices are low, etc.  One could make the case that technology prices are too high (the famous Magnificent Seven) but they have been correcting on their own (see Apple and Tesla’s prices!).  Look for the market breadth begin to widen – more mid-cap and small-cap stock begin to participate in the bull market.  Maybe the international market rally will take hold soon.

 

The Roaring ‘20’s are back!

 

Quote of the Month 

“Your results depend much less on how markets behave than on how you behave.”