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Could the Glass be Half Full?

| December 11, 2023

I’ve talked about the green shoots that have been popping up over the last several months, and so far the market has held in ok.

Inflation has been coming down like we said it should and we would expect it to come down further as the Owners Equivalent Rent (OER) begins to be factored into the data. That being said, we have been mentioning the Leading Economic Indicators (LEI) being negative for over a year now. That, typically, would not bode well for the economy.

Last week I discussed the possible outcomes for the economy and the FED. It’s no surprise for anyone reading this that I am no fan of the Federal Reserve and how they have conducted policy over the last 20+ years. Maybe I’m just old now and can’t get out of my rut, but I like to think that I look at the data and try to make a reasonable assessment of what that might mean for the economy and the markets. I don’t have a crystal ball and don’t know the future any more than others. But things should make sense and have a reasonable conclusion given the data. For instance…

If the economy were to still hum along with inflation well above the 2% level and the labor market tight, you would expect the FED to continue its efforts to slow the economy and bring inflation down. You wouldn’t expect them to cut interest rates in a scenario like that.

On the other hand, if inflation was falling off the cliff and unemployment was rapidly rising, you wouldn’t expect them to continue talking tough about interest rates. You would expect them to soften their rhetoric and even talk about cutting interest rates to support the economy.

While both of those outcomes are still possible, I think you have to consider how difficult it is to thread that needle. How does deficit spending affect interest rates? What will the dollar do relative to other currencies? What is the appropriate price to earnings (P/E) ratio for the markets? Will we end up with just seven companies or might there have to be more companies participating in the economy?

Not to say I know these answers, but it does seem to me that it will be difficult to achieve what everyone hopes for…that “goldilocks” scenario. When everyone feels that way, it probably won’t happen.  Let’s take a look at the AAII investor Sentiment Survey.

That’s a lot of bullishness! It has averaged about 2-to-1 bulls to bears. That is typically not great (as it tends to be a contrarian indicator). That being said, the market doesn’t have to fall apart, it can just take a break and catch its breath.

Meanwhile, the tone of the investment community has turned more positive.

We will find out more about inflation tomorrow as the CPI is published and PPI on Wednesday. Continued moderation is expected, but if the numbers come in softer than expected, that could be an indication that inflation is falling faster because the next part of the business cycle is taking hold. That next part being a recession. But that’s not all together bad, as we need inflation coming down a bit. What we don’t want is too much slowing and too many job losses. That’s where ‘Goldilocks’ comes in…it’s “just right.”

Right now, global PMI numbers are mostly flat to down, suggesting a slowdown to outright recession, depending on the country. Anything above 50 is considered expansion and below 50 is considered contraction. The weakest area right now would be Europe, with China and the US hanging around the flatline for now.

If we do get some small recession or are lucky enough to skate by without any recession, you may see rates come down. Let’s do some quick math!

If inflation gets to 2%, you should expect interest rates to look (at least historically speaking) like the following:

  • FED funds rates in the 2.5% to 3.5% range.
  • 10-year treasury rates in the 3.5% to 4% range
  • Mortgage rates would likely be around 5% to 5.5%

If we could get to those levels, I would think that is the ‘Goldilocks’ scenario. With that on the table, here are some headlines of 2024 market prognostications.

Let’s hope these analysts are correct. Like I mentioned last week, we think an environment like that would be conducive for the broader market to continue to widen out and many of the companies that haven’t participated to catch up.

So, let’s hope the FED can play this correctly and they are able to avoid a bigger recession, while still getting inflation down close to their 2% target.

If you didn’t know any better, you would think my glass is three-quarters full!

Have a great week. If you have any comments or questions, please feel free to reach out to us. And for those needing a gentle reminder, Christmas is now just two weeks away!