QUICKTAKE

December 21, 2024

Market Bounces on Inflation Data and Deal to Avoid Shutdown

The Fed moved forward, as expected, with a 25 basis point rate cut on Wednesday but sent stocks down by signaling fewer rate cuts going forward.

The perception at the time that we may be looking at a federal government shutdown did not help sentiment either.

Yesterday, stocks advanced sharply across sectors as the most recent inflation reading looked encouraging. On top of this, there were indications that a deal in Congress to avert a shutdown would be reached.

The Senate finally voted to approve the spending package early this morning, making it a done deal.

Major U.S. stock indices traded up 1% to 1.5% on Friday, while long-term Treasury yields stabilized around 4.5%.

Hyper-volatile Bitcoin, which drifted to just slightly above $92,000 on early Friday morning from an all-time high around $108,000 just a few days prior, was trading as of Saturday morning above $97,000.

Bitcoin came within a few hundred dollars of the $100,000 mark overnight, shortly after the Senate vote.

While uncertainty around inflation and interest rates will continue to affect market sentiment as we enter the new year, we encourage investors to remain focused on the improved outlook for real economic growth driven by more favorable policy and technological progress.

With the average stock significantly underperforming the mega-cap tech tilted S&P 500 Index, many high quality stocks are now at pre-election levels.

The Bureau of Economic Analysis reported a 0.1% increase in the Personal Consumption Expenditures (PCE) Index on Friday. This figure was lower than the 0.2% consensus among analysts.

While the Consumer Price Index (CPI) is the most commonly used inflation indicator, PCE is the one preferred by the Federal Reserve as it is seen as better reflecting real-time inflation patterns.

PCE takes into account substitution effects, such as switching from one product to another alternative in response to price changes.

Investors have become increasingly cautious about the inflation outlook given the shift in language and the reduction in future rate cut expectations coming out of the latest Fed meeting.

Friday’s low PCE reading offered relief that inflation was not currently flaring up again.

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There is an interesting debate taking place now inside the investment community with regard to how much of the Fed’s recent hawkish signaling (in other words, its reluctance to cut rates) is motivated by expectations of policy changes under Trump.

Jerome Powell has denied that the Fed takes speculation over future policy into account, but many observers find it hard to believe otherwise.

Our view on the rate dynamic is that Trump’s economic agenda will stimulate investor, business and consumer confidence. This is not necessarily inflationary, as tax cuts and deregulation can expand supply, but it does diminish the risk of a recession.

Treasury bonds perform best in recessionary environments—when demand collapses.

There are significant pockets of weakness across the economy now, including housing, but a recession scenario appears more improbable given the positive impact on growth that Trump and the Republican Congress intend to deliver.

Bond investors therefore require somewhat higher yields, given the lower likelihood of a dramatic growth slowdown.

Looking ahead to 2025

A silver lining on the Fed’s more hawkish pivot is that the Fed has given itself more room to react in the event economic growth next year does come in light.

This year-end turbulence in markets is not unusual. With the budget standoff settled and Trump’s inauguration just a few weeks away, we expect the market narrative to shift to potential earnings growth and structural change as 2025 gets underway.

As we noted earlier this week, there has been a significant performance divergence between the S&P 500 Index, which is market cap weighted and therefore tilted towards mega-cap tech stocks, and the average S&P 500 stock, as reflected by the equal weighted index.

December has been a very difficult month for most U.S. stocks. Notwithstanding Friday’s bounce, the average S&P 500 stock has returned approximately 13% this year. This is about half the total return of the S&P 500 Index, which has been approximately 26%.

The average S&P 500 stock is now at mid-September levels. The post-election bounce has largely faded as focus has shifted to the trajectory of interest rates. We view this as good news for stock pickers.

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