by David Picton & Team, Picton Mahoney Asset Management
Equity markets seemed to be in the throes of maximum exuberance as 2023 drew to a close. Investors have embraced an immaculate soft landing (in the U.S. at least) where inflation has been tamed, the economy is slowing but remains in growth mode, unemployment rates are expected to stay muted at under four percent, the Fed has pivoted policy just in time and is prepared to add significant support in March just when the economy needs it, the U.S. dollar has weakened, taking accident risk off the table (especially in emerging markets) and S&P 500 earnings have bottomed and will likely grow considerably in 2024. Wow! It’s amazing how a market narrative can change so quickly over the course of one quarter.
However, investor positioning is now stretched on the long side, sentiment is exuberant and valuations seem to have already priced in this perfectly immaculate scenario. We believe a lot has to go right in 2024 to justify any meaningful upside in both stock and bond prices from current levels. Meanwhile, there are also some inconsistencies in current market expectations that will likely be increasingly difficult to reconcile as the year progresses. One such inconsistency: aggressive Fed easing already baked into forward rate markets, which suggests significant economic weakness may be just around the corner, set against forecasts for bullish earnings growth. A scenario where earnings accelerate is not one where the Fed will likely be cutting interest rates rapidly – or perhaps even cutting rates at all.
It appears that market bulls want to have their cake and eat it too. We think the near-term setup for risk assets isn’t overly compelling, and that 2024 will bring back its share of volatility as the current soft landing narrative is challenged. We are also concerned about an emboldened Fed Chair who suddenly seems to be embracing forward thinking (instead of just trend following) in his policy decisions for the first time in his tenure and seems convinced that the inflation battle is now over, even while supply-side constraints continue in key areas of the economy.
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