Escalating tensions in the Middle East. Shipping attacks in the Red Sea. Iran and Pakistan exchanging attacks. An ongoing conflict between Russia and Ukraine… And the markets hardly seem to notice.
In this seasonally bullish period, all news (even the bad) is good news. Right now, market participants are exuberant and will soon enter a state of downright euphoria in the coming months. Wars, famine, drought… who cares? The market will melt significantly higher regardless of what unfolds on the global stage. Historically, we’ve seen this kind of behavior at important tops of financial markets.
It all seems rosy right now: economic data continues to show robust consumer confidence, strong retail sales, and high levels of employment. Though the stock market began the year with a minor pullback, it bounced back fast and is trending up again, just as we projected in our December blog. Yet, the cracks in the economy are starting to show and the underlying fundamentals are slowly deteriorating.
Our analysis indicates that we have entered the final stage of the bull market, one that could last for several months. The savvy investor may be able to squeeze out an additional 10% to 20% during this last phase, with the potential for truly explosive action that exceeds all expectations.
Enjoy the climb, but beware of the risks. Here’s what we’re watching:
Bitcoin: On January 10, the SEC approved 11 spot bitcoin exchange-traded funds (ETFs), providing investors with the same access to bitcoin that they currently have to other investments like mutual funds, stocks, and gold. Korea, Hong Kong, and Brazil are planning to launch similar ETFs and derivatives on the bitcoin ETF. It appears we are at the dawn of a global euphoria in cryptocurrency.
High Yield Bonds: These are in demand, suggesting an appetite to invest in the riskiest of assets. They typically offer higher coupons than government bonds or high-grade corporate bonds and have the potential for price appreciation in the event of an improvement in the economy.
Employment: Initial unemployment claims are a useful leading indicator. They usually increase before the economy enters a recession. As of January 13, 2024, the seasonally adjusted initial claims in the United States were 187,000, a 16,000 decrease from the previous week. This is the lowest level since September 24, 2022, suggesting that people are at work and the economy continues to grind. It also suggests that we are currently NOT in a recession.
Manufacturing: As of December 2023, the ISM Manufacturing New Orders Index was 47.1 points, down from 48.3 points in November 2023. A reading over 50 shows orders have risen from the previous month, while a reading below 50 shows a decline in orders. This is one of several data points suggesting that cracks in the economy are beginning to develop.
Deflation: With all the strong economic reports rolling in, betting folks seem to think that the Fed will unlikely cut rates at the Federal Open Market Committee (FOMC) in March. Instead, all eyes are on a first-rate cut in May. This suggests that market participants have incorrectly priced in a soft landing, one in which the Fed successfully reigns in inflation while avoiding a recession due to its higher-for-longer monetary policies.
A rate cut may seem positive on the surface because it will ease liquidity conditions. However, we see a high risk of the Fed using the rate cuts as a strategy to stimulate demand. By then, it will be too late: workers will have been laid off and the business cycle will have turned. We believe that the market is not pricing in this very real risk. We might celebrate some disinflation in the short term, but deflation is our primary concern for the second half of 2024 and beyond.
For the 12 months ending in December, the annual inflation rate in the U.S. was 3.4%, compared to a previous rate of 3.1%, according to the U.S. Labor Department. Truflation paints a different picture. The Truflation dashboard is a data visualization tool that calculates the most recent US inflation rate and price indexes using millions of data points measured in real-time. The Truflation model calculates the current U.S. inflation rate at 1.86%. If Truflation is correct, the Fed will be proven wrong once again. Market participants may congratulate them for reigning in stubborn inflation, but the Fed will be deeply worried about setting us towards a disastrous path of deflation.
But bad news is good news, right? At least for now, we can enjoy the climb. Here’s how: the market has been ripping higher on the backdrop of a strong dollar. As the dollar starts to weaken, we expect small caps to do very well and outperform their bigger cousins.
And up we go!
