End of year Market Commentary – J Powell Spikes the Punch Bowl

US : There was an air of quiet trepidation on Wednesday when J Powell stood before the lectern to deliver the thoughts of the Federal Reserve Committee on the economy and likely monetary policy going forward. Opinions varied, but the overall consensus was expecting Powell to push back against the recent loosening in financial conditions and to deliver a hawkish sermon. Concern soon morphed into euphoria as instead of talk of potentially more tightening needed, Powell’s press conference came as close to promising early rate cuts as a central bank could ever do.

Arguably, this is the moment we have been waiting for as the Fed has paved the way for lower rates and is now prepared to execute a pivot toward easier money. Even the most bullish commentators were caught off guard by the central bank’s signal and with the punch now spiked, investors let rip as the Dow Jones Industrial Average and Nasdaq 100 surged to records. Yields tumbled as bonds soared, credit boomed and risky assets around the world rallied. So what exactly did he say? Well, highlights for the bulls included ; an acknowledgement that rates would be cut before inflation got to 2%, that conditions were now very restrictive (implication they should be eased), the committee is now discussing when rates should be cut. The fed funds futures markets moved immediately with cuts now priced in from as soon as March and carrying on all year, with the difference from the September position shown in stark contrast in the chart below.

Quite what triggered such a volte-face at this meeting is unclear, but I have a hunch that politics might have something to do with it, as certainly the recent economic data hadn’t thrown up any pressing reason to act now – retail sales have been strong, the jobs market resilient and even the last inflation print underwhelmed. The politics argument goes something like this … next year is an election year and the Fed cannot be seen to be influencing the result. If they started cutting rates in the second half of the year, nearer the time of the election it could be perceived as the Fed priming the economy and giving a direct boost to the Democrats. If on the other hand they have started cutting earlier in the year and merely continue in to the third quarter election season, then it would look less contrived and more part of a process. An extreme view is that actually the Fed is trying to influence the result, as by stimulating the economy earlier, there is a much better chance that Biden will stay in the White House. That conspiracy view is less about keeping Biden in office and more about keeping Trump out, which is a real threat as he is leading in the polls. You can be absolutely 100 per cent certain that J Powell would be happier with the current status quo. But whatever the reason, it is good news for risk assets in the short term and it looks likely the Santa Rally could continue in to year end.

UK : I wonder what Andrew Bailey made of the news on the Wednesday night, as he had to pronounce the views for the BoE the following day. Any hopes that we would get a continuation of the party were soon dashed, as he effectively ‘stuck to the sparkling water’ in the press announcement and continued with the hawkish narrative of previous meetings. He sprung no surprises, leaving interest rates at 5.25% for the third time in a row and pushed back against the prospect of near-term interest rate cuts. The MPC stuck to the familiar script, saying that policy will be ‘sufficiently restrictive for sufficiently long’ and that ‘monetary policy is likely to need to be restrictive for an extended period of time’, blah , blah , blah ….. The committee even downplayed the softer-than-expected wage and inflation since its November meeting saying that ‘it is important not to over interpret developments in anyone measure’.

Unsurprisingly, this dampened the enthusiasm of UK equity investors who had got caught up by the party in the US and the FTSE 100 drifted lower into the weekend, although UK Small Caps continued the rally that has seen them catch with large caps over the last 6 months.

Europe : It was a similar party spoiler exercise when we heard from the ECB. ‘We should absolutely not lower our guard’ said President Christine Lagarde as she insisted that the Governing Council did not discuss rate cuts at all. Market participants understandably remain sceptical that the ECB will be able to maintain their relatively hawkish stance for long, judging by the recent steady fall in European debt yields. The Governing Council discussions featured some irritation about this move in lower borrowing costs and some members were confounded by the extent of easing priced in by investors. Officials are now not expected to revise their stance before March, when the ECB will receive an update on the outlook for growth and inflation in the 20-nation euro zone. Much can change over that length of time and it certainly looks as if bond investors are pricing in a change of mood from the ECB by then. European equities didn’t quite party like their US counterparts, but the Bourses finished the week higher overall.

China : Probably coincidentally, but you never know, China decided to unleash some good news of its own, although the move could be viewed as more sending out invites for a party to start next year, as both the economy and equity markets have shown little signs of life this year. But the news was significant and included a move to pump a record amount of cash into the economy and an announcement of renewed support for the property sector. The size and double combo of measures was sending a more powerful stimulus message to investors after piecemeal approaches over the last 6 months have so far underwhelmed. The market reaction was muted, but the MSCI China did at least finish the week higher for the first time in a while.

2024 Outlook :

Now as this is the last Market Matters of the year, Ash has made me promise to get off the fence (my most comfortable position ) and put down some thoughts on what I see happening for financial markets next year. I should caveat these straight away (you can already sense my reluctance to leave the fence) that they are my personal thoughts and not reflective of the collective views of the AQ Investment Committee and that we are not about to execute our own volte-face and to start taking aggressive asset allocation bets. We will stick to our knitting next year with the AQ portfolios, keeping asset allocation in line with peers and continue to add value through fund selection. Rather than deliver a War and Peace Outlook, I am sure your inboxes have also been swamped by lengthy prognostications, here is just a few thoughts on how things could play out.

At a top down level, I think 2024 has all the potential to be even better for investors than 2023 is turning out to be, although in a sense I think a lot of the gains in both bonds and equities I was expecting next year have already been pulled forward in to this year following the recent Santa Rally. Putting numbers to thoughts, I think with luck we could get double digit returns from equities and high single digits from bonds (that would have been higher, but yields have already backed down a lot in the last few weeks). And throw in the fact that UK cash will probably return 5 % and I think a Balanced Portfolio could well deliver low double digit returns next year. The reason for my optimism is that economic growth is more resilient than I expected and that the US will most likely avoid a recession and that the UK and Europe should only suffer a mild one. Essentially the soft-landing, goldilocks scenario will play out.

Frame that with a loosening in monetary policy from all the Western Central Banks and there is a good chance that growth could be reaccelerating by the end of next year. I happen to think, that the consumer still has money to spend and a willingness to do so, given the increase in wages and my long held belief is that the trickle-down wealth effect from baby boomers is completely underestimated.

There is also a healthy degree of caution still in money managers and an awful lot of money sat in cash to come in. All significant bull markets were disbelieved even when they were actually underway. They take people by surprise, as there are always many credible arguments why new highs should only be treated with extreme caution and they are sustained by a steady stream of investors sat on the side-lines eventually capitulating. I remember last year I was out on a limb, put on the ‘naive optimist step’, for suggesting an unexpected bull market may have started, similar to the one that begun in 1982 ……

From early this year ….‘Although no one can predict the future, there is one particular episode in history that parallels the events of 2022 and that is the early 1980s. Back in 1981 central banks were raising interest rates to combat sticky inflation which had been exacerbated by an Oil price shock caused by the Iran / Iraq war, a narrative that closely matches the events post the Ukraine invasion. Throughout 1981/2 equities sold off and fixed income was hit hard as rates went higher (think 2022). But eventually the central banks brought inflation under control and monetary policy was eased. Yields came down sharply (prices went up) and the equity markets took off in meteoric fashion. The bull market that followed the early 80s inflation scare lasted from 1982 to 2000 and saw a recovery in the US equity market ‘

So I thought I would revisit the charts I was producing back then and see how things now compare and was actually shocked to see the similarities, with the US market now breaking above the previous high almost exactly at the same point two years after the sell off of 40 years ago – spooky!

What then ensued was nothing short of spectacular for investors, as equity markets enjoyed the most profitable bull market in history. Digging into the reasons why that bull market was so successful, I think there were a number of factors – healthy cynicism at the start, good demographics (baby boomers) but arguably it was the arrival of the PC and the productivity gains that ensued – which also helped keep a lid on the inflation that bedevilled the 1970s. Here too, I can find a good parallel with what is happening now, as I believe the widespread adoption of AI and the confluence of a lot of new digital technologies could also create a structural shift in productivity, helping keep inflation tamed and corporate earnings growing.

Now I am aware that this outlook is very US centric in thinking, but as a rule where America leads, the rest of the world (ex Asia) follows. I do think US exceptionalism will probably continue as their companies are dominant in the technology space and that the higher valuation multiples are justified. But I think there are decent returns on offer in the UK and Europe, which will benefit from the start of a cyclical economic recovery when falling rates kick in, though this probably not likely to play out until the tail end of the year. China could also join the party next year as sentiment is so poor it can probably only reverse, valuations are very cheap and there is still a strong will and means for the authorities to engineer more of an economic recovery.

Next year will undoubtedly have a new set of challenges we cannot yet imagine, but the converse is also true in that it will usher in a new set of opportunities. My current glass half full disposition leads me to think more good than bad will happen in the months and years ahead. So, I will finish by thanking you for your support, wish you a Merry Christmas and hope for a prosperous New Year.