Note Précis Dec. 14, 2023: Markets Dance – To What Tune Sometimes with mirth, excess euphoria is attributed to retail investors but it is not the entire story. This aspect needs consideration at year end 2023. Whether bespoke or mechanical or in this age of high frequency activity and basically using similar variables, institutions can be pressured into window dressing, It is especially so when as in 2023 overall, equity leadership has been narrow and rigorous credit assessment been scarce in fixed income. While October 1987 was extreme, it was instructive that a wholesale swing in institutional positioning begets elevated volatility.
Capital markets appear to have already danced to at least three tunes. Into the end of 2023 and despite central bank reticence, capital markets appear reverted to earlier momentum mojos expecting early administered rate cuts supposedly with inflation imminently lower still. The breadth of this consensus seems massive. Currency markets appear sedate. Despite having lower than U.S. rates, the Canadian and Australian dollars seem stabilized. In Europe, spreads seem narrowed between benchmark German bunds versus conservative Dutch and weaker Italian fixed income. Both junk corporate and emerging country also appear to have participated in rallies. In an immense move, Japanese 10 year JGBs yields have been dropping. The credit crisis into 2008 illustrated the risks of ignoring elevated leverage and systemic risk.
The Federal Reserve in its FOMC statement of December 13, 2023 did link maintaining Fed Funds at 5 ½% with also keeping policy options open. Ranged from the Bank of Canada and Reserve Bank of Australia earlier as well as the Bank of England and the ECB now concurrently have kept rates in the 4 ½-5 ½% band. None can afford a currency stress of premature ease.
Stiff central bank resolve as currently and widely signaled as well as more fragile politics, trade and political economy strictures appear underappreciated. Given the current consensus within capital markets, major volatility impact would ensue from even small changes expectations from currency to fixed income to equities.
Any one of several political sparks could set off adversity for the present complacent capital market consensus. Global economic growth is weak and fractious. Despite bilateral summits such as of China and the United States and multilateral ones, from key minerals to information technology, managed trade and strategic stretch for protection of supply tensions appear ongoing. The south China seas have expanded physical tensions just short of war. Actual war continues from the Caucuses to the eastern borders of Europe to now North Africa and straddle key transport and hydrocarbon sources of energy. Despite COP28, security of expanding alternate energy supply appears at best a work in progress.
Aspects of inconsistencies and momentum appear in equities. The late rally in 2023 has been replete with S&P 500 valuation benchmark to 20+ P/E and for 30+ P/E for the narrow coterie leadership within Information Technology. On both risk premium and earnings delivery capabilities, equity valuations appear extended on lower interest rate expectations. Diversification may be in order, both within and between growth and value, with Financials crucial and Information Technology capped for potential risk on valuation and delivery dispersion reasons.
Seasons Greetings E.o.e.