We're told the market doesn't like surprises. Not so last Wednesday when the Federal Reserve Board shocked many Wallstreet experts by indicating there would be two more 0.25% interest rate hikes before the end of the year.
However instead of falling after this 'hawkish' rhetoric, the S&P500 (20x PER) and Nasdaq (29x) both climbed 1.5% on the week - despite their already lofty valuations and the super inverted 3m vs 10y Treasury yield curve. The US dollar weakened too.
So what’s going on?
Well first & foremost there’s currently a significant FOMO effect. In fact due to the narrowness of the rally (re #ai mania), many ‘active’ fund managers have materially lagged their benchmark indices in 2023.
Meaning they're now in major ‘catchup’ mode. Not only chasing the ‘Expensive 7’ (re #NVDA, #MSFT, etc). But also piling into several other sectors (eg US homebuilders, industrials, etc) in the hope that they will become the next winners. Whilst equally, broadening out the market rally.
Clearly this rising tide is great for everyone. Albeit like the ocean, I suspect it will turn over the next 6-9 months, once the Fed’s tightening measures eventually impact the economy.
Sure the Bulls continue to point towards a ‘soft/no’ landing - which is definitely possible.
Yet to me, the most likely outcome for wage growth to SUSTAINABLY fall to a level consistent with the Fed’s 2% CPI target, is if the labour market cracks (re 4.5%+ unemployment).
Meaning if & when this happens, then today's stretched equity valuations probably won’t defy the gravitational force of >500bps of interest rate hikes.
Don't get me wrong though. I’m not bearish on quality UK small/midcaps - as many of their ratings have already priced in recessionary conditions.
In fact over the past couple of months, my own portfolio has enjoyed positive returns (+16% YTD vs +2% FTSE - see below) and I’ve recently added 4 new positions.
Firstly, the world's largest inter-dealer broker TP ICAP (#TCAP), who I believe is significantly undervalued (Target Price 250p), especially given its proprietary data analytics division Parameta Solutions.
Next, I've also purchased shares in neonatal medical devices firm Inspiration Healthcare (#IHC, TP 80p), customised/ASIC chip designer Sondrel (#SND, TP 60p-90p) and premium brick manufacturer…
Afternoon Paul,
That's a good question, here are some possible reasons:
They paused, which while priced in, is more bullish than a hike. I don't think the market really expected a cut so soon.
The debt ceiling has been suspended for the next two years [i.e. until after the election]
The FED has never raised rates after a pause, at least for as far back as I can remember.
Real rates will likely increase over the next few months, due to CPI base effects and ongoing balance sheet reductions, removing pressure to make additional hikes.
As an aside, I get 'soft landing', but how would a 'no landing' work?
Congrats on this year's positive returns.
