Santa comes early

It’s an early gift for equity investors, because there’s been a pretty sustained rally across markets over the last several weeks, and I think it’s both on the realization of lower ten-year yields, and the expectations that market participants now have for the Fed to start cutting rates next year. The catch is that I can’t think of a time when the Fed was able to cut without some sort of correction in the equity market, or when they have cut with the equity market at an all-time high. So, it seems to me that, if cuts are to begin in March of next year, and if they are going to be in the order of 100 basis points (bps), as the market currently implies, then that is very much a recession call.

The rally was led by the tech sector, and that makes sense. The prospect of still strong future earnings, coupled with lower rates should be good for tech. But, where I have concerns is that everything else simply followed – the truth is, not every company can ski the tracks that tech cuts. For the corporate sector to work out as smoothly as its equity rally implies, I think we would need to see a near perfect soft landing. It’s happened before – in 1995, and in 1985 – but it certainly needs some very precise piloting.

So how to play things from here? I suggest a healthy skepticism of tech valuation, and prefer some of the more defensive, higher-quality, plays. I like bonds, and bond-like equivalents such as Utilities and Real Estate Investment Trusts (REITs), and possibly Healthcare depending on one’s view of the political landscape there (i.e. to what extent Healthcare will become a battleground in an election year).

Will equity markets retain their confidence in 2024?

Well, two or more dips of around 5% or more in any year are common, and I would actually anticipate a correction of perhaps 10% or more next year – but a correction, not a full bear market. I think we’re seeing the start of a Santa Claus rally, which is nice, but perhaps the naughty aspect is that it’s borrowing from next year’s returns.

Finally, remember to diversify. Santa travels abroad too, and so should we when looking for opportunities.

– David