Watch the CPK Market Action Report: December 2023

Stocks ripped higher in November as extreme pessimism morphed into confidence about interest rates and inflation. Will the Christmas rally continue through the end of the year or have stocks already outgrown their forecasted earnings for 2024?

Watch the Market Action Report now:

Market Action Report

December 2023

INTRO TAG

That action starts now!

INDEX PERFORMANCE RECAP

Stocks posted a tremendously bullish gain for the month. The S&P 500 posted a 9.1% gain while the Dow Jones Industrials jumped more at 9.2% marking a new high for 2023. The Nasdaq was the standout, surging 10.8% for the month.

EQUITY UPDATE

Stocks roared higher in November. Will the S&P 500 rally through 5,000 or decline through 4,000? There are four potential variables that will most likely make that determination. They are economic growth, timing and size of Fed rate cuts, inflation, and earnings. I will elaborate on each of these towards the end of this video in the “Wrap.”

BOND UPDATE

Bond yields all fell throughout the month. The 5yr settled in at 4.29% while the 10yr and 30yr closed at 4.11% and 4.21% respectively. The market is aggressively pricing in a less than hawkish Fed and leaving itself very susceptible to an even mild disappointment.

COMMODITY UPDATE

WTI Crude retraced its gains from last month to close out at $75.96/barrel pressure by Saudi Arabia’s efforts to deepen collective production cuts. With the market pricing in some sort of further output-limiting deal, risks are building for the market if OPEC+ fails to deliver and a drop to $67/barrel remains a real possibility if a price-supporting deal isn’t reached.

Copper spiked higher to close at $3.83/oz. Looking ahead, the recent strong price action in copper supports the case for a soft economic landing and we will look for that bullish trend to continue to confirm stable growth expectations globally.

Gold finished much higher at $2,038/oz. The yellow brick is trading near multi-month highs and appears poised to make a run at the all-time highs in the weeks ahead. Whether that plays out will largely depend on whether the November declines in the dollar and bond yields reverse, as they played a critical role in the big November gold gains.

CURRENCY UPDATE

The dollar declined throughout the month finishing at $103.42. Bottom line, markets pushed the dollar higher in late summer/early fall on the expectation that U.S. growth would remain better than the rest of the developed world and that the Fed was the most likely developed central bank to hike rates. Now, growth has cooled, and the Fed has signaled it’s done with rate hikes, so we are seeing that dollar premium unwound—and it took the recent softening in data to push the dollar lower.

Looking forward, for the dollar to go sustainably lower from here, economic data will have to point more towards a real slowing of growth, and it would not surprise me to see some digestion of the dollar declines around the current levels, again barring any disappointing data.

ECONOMIC UPDATE

For the past several weeks the message of most economic reports has been that economic growth is starting to lose momentum and that was largely reinforced by the data last week. Positively for markets, the data wasn’t bad enough to spike hard landing worries and dovish Fed speak helped push yields lower and support stocks. But make no mistake, data is starting to point towards a loss of economic momentum.

The key report last week was the ISM Manufacturing PMI which missed estimates implying a continued contraction in the manufacturing sector.

The other economic report that pointed towards a potential loss of economic momentum was Continuing Jobless Claims, which rose to the highest level since November 2021. However, companies appear hesitant to lay off workers but the fact that it’s taking the unemployed longer to find a job means that companies aren’t really hiring, either. That’s usually the first mover in a slowing labor market.

Going forward, dovish expectations have underwritten the November rally. So, those expectations need to be continuously reinforced by economic data going forward otherwise markets risk giving back a large part of that big rally.

THE WRAP

I mentioned earlier four variables I think will determine the direction of this market. I left inflation out from my outlook as I don’t think it will have a direct influence on the markets in 2024.

As for economic growth, based on recent data, I believe that growth will slow more than the consensus and perhaps slightly contract, but it will not collapse into a deep recession. Economic theory and practical experience are clear: The longer inflation remains high, the more it erodes discretionary spending, and that eventually slows growth. We’re still working through the “eventually” part of it, but both the data and my anecdotal experiences tell me that the sustained high prices are now biting harder into consumer budgets, and that’s likely to continue. Similarly, utilization of previously low interest rates has helped to cushion the impact of higher rates on the broader economy. But the longer they stay high, the more of a weight they will present. With wage growth lagging inflation and rates still high, I do believe we will start to see evidence of a clear loss of economic momentum in the coming months. But there are two important supports that I believe will prevent this from becoming a serious economic slowdown.

First, the Fed’s balance sheet is still massive and that provides a huge liquidity buffer against a more meaningful slowdown. The Fed’s balance sheet currently sits at $7.8 trillion. Pre-pandemic, it was $4 trillion. That massive liquidity boost (even after QT) provides a liquidity buffer that should help prevent a deeper economic contraction. Second, the labor market is too strong to imply a deep economic slowdown. Yes, employment is a leading indicator, but even if we see the unemployment rate rise a full percentage point through June 2024 (something that’s very unlikely), it’ll still just be at 4.7%. That’s historically very low and reflective of full employment. It’s hard to have a deep economic slowdown without a major increase in the unemployment rate (i.e. above 5%).

Is this bullish or bearish? It’s bearish, but only because the market is so richly valued. A stagnant or slightly contracting economy isn’t a recession. It probably equates to a 16X-ish multiple but not an outright disaster.

The second variable is Fed rate cuts. The market is too aggressive in its expectations for Fed rate cuts both in timing (rate cut by May) and in size (100 bps in 2024). First, I don’t think the Fed can reasonably cut rates unless core CPI is very close to, or under, 3.0% y/y and I’m not confident that will happen in the first few months of 2024 unless we get a sudden and deep drop in housing or rent prices (which doesn’t appear to be happening). Second, Arthur Burns. The 1970’s Fed President is generally regarded as one of the worst because he cut rates too early, only to have previously thought-to-be-vanquished inflation bounce back. The Fed then had to hike rates again and that led to the stagflation of the 1970s and 1980s. The Fed doesn’t make the same mistake twice (they make new mistakes) and as such, I think the Burns legacy looms large over Powell and the only way we get rate cuts by May is that growth is slowing more dramatically than markets expect.

This would be moderately bearish. Most of the recent 500-point rally in the S&P 500 has been driven by the idea that the Fed will be cutting rates by May and that it will cut rates dramatically by the end of 2024. That’s possible, but if that expectation must be reversed, then the S&P 500 could easily give back 250-350 of the recent 500-point rally.

Next is the earnings. Earnings will grow in 2024, but not at the near-10% expectation currently priced into the markets.

Why do I think so? 2023 S&P 500 earnings will be around $225/share. Current expectations for S&P 500 earnings in 2024 are about $245/share. That’s 9% annual earnings growth, an ambitious number for the consensus economic environment, even considering AI could continue to help boost tech earnings and I do not think earnings growth will get there. First, I think the slowing of growth will depress general consumer spending, which will be a headwind on earnings. Second, corporate America benefited from the spike in inflation over the past few years as they were able to raise prices, increase margins, and suffer no demand loss. However, if you’re like me, you’re seeing evidence of disinflation across the spectrum: Goods, electronics, airfare, travel, hotels, etc. Companies are once again competing on price (remember those days) and I believe that will negatively impact corporate margins. So, I think companies can grow earnings in 2024, just not as aggressively as the market thinks.

Again, this is mildly bearish. Movement in earnings estimates are not as impactful as movements in the market multiple. For instance, expected 2024 S&P 500 earnings falling from $245 to $240 just equates to a reduction in “fair value” for the S&P 500 from 4,655 to 4,560 using a 19X multiple, or about 2%. But it still matters, and this is a potential source of risk for markets as we start 2024.

CPK FOCUS

For the month of December, our models currently hold a 50% allocation in the money market due to the current economic environment and the overbought position of the market itself.

Our broad focus is on Commodities, International and Domestic Equities.

As for Commodities, our focus is on Energy and Agriculture.

In International Equities, our focus is on Europe Emerging, Latin America and Europe Developed.

Our focus on Domestic Equities is on Large Cap Growth, Large Cap Blend and Mid Cap Blend with an emphasis on Technology, Industrial, Energy, Consumer Cyclical and Basic Materials.

CPK DISCLAIMER

As a reminder, my current allocation is not a recommendation. Regardless of what happens next, investors like you need to have a simple and yet solid financial plan that reduces RISKS, COSTS and TAXES while securing the necessary income you need to maintain your lifestyle throughout retirement.

If you don’t have a plan OR you’re not comfortable with the plan you have, call me today to get pointed in the right direction.

I’m Chad Kunc and that puts a wrap on the December 2023 Market Action Report. Thanks for joining me. It’s time for me to get back to the markets.

And that action starts, NOW!