Markets gone wild

0:05Pushkin. What the heck just happened? Since the Fed meeting last week, markets have gone bananas. We've already busted through a lot of targets that investors and analysts had for 2024 because stocks and bonds are going to the moon. What on earth is going on? We're going to help you figure it out, hopefully. This is Unhedged, the markets and finance podcast from the FT and Pushkin. I'm Katie Martin, the markets editor in London, and I'm inexplicably not joined by Ethan Wu, who has been allowed to go on holiday or something? We do let the young people out of the office once in a while. What the?

0:46Who's going to do all the work? We are kind and beneficent overlords. Rob Armstrong over there in New York, you are indeed kind and generous in New York, writing your unhedged newsletter, but you're not as kind and generous as Jay Powell, chair of the US Federal Reserve. What has he done? I think of Jay as a very restrained and even-tempered fellow. But I think in that press conference last week, he came very close, and this is a good New York word, to cavelling about the state of the economy. I'm sorry. Bristling. I think that's a Yiddish word. I'm not sure. But when you cavell, you kind of bristle with pride.

1:31It's like the parent at the kid's sporting event after the kid scores a goal. They travel. He was as prideful. Like he got opportunities to be his usual dour self. You know, reporter says, well, if you do cut rates as many times as you expect next year, as much as the committee expects this year, is that because the economy is slowing? No. Basically was the answer. It's because inflation is coming under control. Let's just rewind a tiny bit, though. So the Fed left rates on hold. Yes. Still, you know, 5 % and change. But there was some new stuff that came to light. The dots. Which includes the dots.

2:14Everyone loves the dots. So for those who are not familiar, Fed rate setters put little dots on a chart to show where they think rates can or should be at certain points in the future. and you can get a little bit kind of horoscopy about the dots, honestly, but the dots are the best kind of guide we have as to what the Fed is going to do next. And those pretty little dots. Dots moved. They moved a lot. So in the last set of dots, which came in September, there were still a couple of members of the Fed's open market committee, the rate setting committee, who were way out saying rates are going to have to be in 2024.

2:55There were a few of them still stamping their foot and saying rates are going to have to be higher still in 2024. And the group as a whole thought, you know, we were going to be in that 5 % range into 2024. And then all those outlier hawks have been shot out of the sky and everybody moved down to the 4 % range. Right. So there was like this big change in the outlook. And as you say, Jay Powell, he's not one to pass up an opportunity to be a bit miserable, but instead he was saying, first of all, victory lap. All those bozos who said we were heading into a recession were wrong. Yes. And there was just kind of quite a sort of, no, no, no.

3:37Yes. You messed this one up. He did nod to the fact that things can still go wrong, but... Of course. It was, as I said, by his standards, quite demonstrative. But he was also saying, OK, sure, inflation is still above target, but we don't have to wait for it to hit 2 % before we start cutting. And in fact, he cautioned against waiting until everything was exactly at the 2 % target before they started to ease policy. And what was the phrasing? Rate cuts are coming into view or the discussion of rate cuts is coming into view? Yes, we're not talking about it, but we're thinking about talking about it.

4:13That wasn't his phrase, but as best as I could tease out the message. But the real point, the most salient point for this discussion is not what Jay Powell said or what we heard him say, but what markets heard him say. And markets heard him doing backflips and playing a little trumpet. So he allowed as how the open market committee thinks there's going to be three rate cuts. That's their aggregate judgment is three rate cuts for next year. Next year, yeah. And the market said, did you hear him? He just said six. Yeah. And so now the market expects the federal funds rate to fall below four next year.

5:00So that's six, five, six cuts. and correspondingly every risk asset that is not nailed down uh has leapt up off the floor and is doing a little dance around you are enjoying your your dances and backflips today rob armstrong must be just trying to keep things lively it's the christmas christmas sherry but so um yeah so the market is doing some weird stuff some stuff that makes sense and some stuff that makes less sense The stuff that makes sense is that if the market really does think we're going to get six rate cuts next year, then accordingly, government bond yields have collapsed. And that kind of makes sense if that's what the market thinks, even if that's not necessarily what the Fed thinks about how far they're going to go.

5:45So government bond yields collapsed because prices have gone up so much. And we're right back at levels that we haven't seen since at least the summer, since everyone was talking about higher for longer. and stocks have shot up to very close to all-time highs. So it's kind of right, crisis over. Yeah. So the funny thing is, though, right, we can talk about this more later on, but these things don't make a lot of sense together. Oh, let's talk about it right now. So either growth is going to be good, in which case the Fed is going to be cautious about how many times it cuts rates, or growth is going to be less good and the Fed will cut more.

6:31That's how I would frame reality. What the market seems to be hearing, and we're not the only ones to point this out, by the way, is that growth will be good and the Fed will not be cautious about cutting rates. So you've got all these kind of unicorns there at their Bloomberg terminals trading away with their little hooves and they're saying, okay, so the Fed is going to cut rates six times, but there's not going to be a recession. So buy stocks. And one of these sets of people has got to be wrong here, right? I think that's probably true. Although there is a more benign interpretation of what markets are doing, which is that they are kind of cutting the worst case scenario out.

7:15So the stock index that has risen the most of the major ones is the Russell 2000 stock index, which is where we put our small stocks in America and increasingly our small crappy stocks. Value, value. Value. I'm sorry. That's what I meant to say. A lot of these stocks have balance sheets that are highly levered. They're therefore a rate sensitive. And since Jay opened his big mouth last week, those stocks are up like six or 7%, which is a huge move in just a couple of days. So it's like the stocks that would have been in the most trouble if something bad had happened in 24 are the ones that are moving the most.

8:01You could interpret that as a market saying, well, the Fed's not going to tighten us into a recession. Inflation is kind of under control. The really bad stuff is not going to happen. And that should give us a couple of more percents. It doesn't mean next year is going to be all rainbows, crumpets and jam, snow days and whatever kind of good things you have over there in England. But it does mean that the worst scenarios have been eliminated. But like some of the investors that I speak to are like, OK, so you've got this incredibly benign set of circumstances all baked into market pricing. This makes me nervous, firstly, because we've already busted through where I thought we would end 2024, never mind 2023.

8:47But also where you've got markets that are priced for perfection. It doesn't take very much to tip things into imperfection and for bad things to happen. This is what people are worried about. Now, Rob, I am told that you know how we always ask in these situations, hey, Rob, what can go wrong? Apparently, that makes us terrible people because journalists are always trying to think about things that go wrong. Nonetheless, what are the challenges here, Rob Armstrong? Several spring to mind for me, but you go ahead. OK, so stocks have become expensive again. One of the great things we might have said at the beginning of 2023 is that stocks looked pretty reasonably valued.

9:24So the S &P 500, as I remember, was at something like 18, which is kind of historically normal. Now it's at something like 22 times earnings. And 22, you're thoroughly on the expensive side. And even more importantly than that, the seven stocks that are doing all the work to keep that index up, the Magnificent Seven, the Salubrious Seven, the Sexy Seven, Amazon, Microsoft, Apple, Alphabet, Meta, Nvidia. Have I missed any? I think I got most of them anyway. These stocks look very expensive indeed. Yeah. So that's your point about perfection being difficult. Things that go wrong, we can get a one or two slightly spooky inflation reports.

10:13That's the thing. And everybody realizes it's not going to be six cuts. It's going to be three or it's going to be two. The history of inflation in America is not a history of a line that goes straight up and then comes straight down. It is the history of lines that oscillate. And the Fed is very aware of this fact and has mentioned it on several occasions. And so if they get even a hint that there is going to be an accelerating pattern of inflation, they're going to change their attitude very quickly. because the only thing worse than being the Federal Reserve Open Market Committee that didn't see in time that inflation was serious is being the Federal Reserve Open Market Committee that defeats inflation and then lets it ramp up again.

11:08Yes, nobody wants that. Nobody wants to be remembered in history as that group of people. The main things that can go wrong do fall into those buckets, right? One is that the inflation monster has not been vanquished after all and that it comes back and you get like one kind of toppy inflation number. It doesn't have to go back to six, right? No, it just has to tick up a little bit and get the Fed thinking. And this exuberant rally is going to be killed dead. Or we do get the recession that everyone has wrongly been saying is going to come any day now for at least a year. and then stocks kind of shouldn't be up where they are, again, kind of relating to your valuations point.

11:52So the point you're making is that we're not in that different a situation than we were before. But there's other stuff that can go wrong. There's an awful lot of politics next year. What is it, like 40 % of the population of the earth is going to be subject to an election next year? this might include the rainy little island of the UK. Yes, definitely will include the massive continent of the United States. Here's a prediction for you, though, Katie. I don't think any of the politics is going to matter. My view about markets is that they don't understand politics very well, perhaps because nobody understands politics very well.

12:35And therefore, they have a strong tendency to pretend like nothing has happened. You know, we did get a rally when Trump was first elected because corporate tax cuts were such a big part of his agenda. But I think that was kind of anomalous. Like, I don't think the market is going to make many bets on the fiscal policy or the central bank appointees of the relative presidents. I think, you know, the market is just going to ignore the whole thing. I mean, we have been harping on this things going wrong stuff, but I'm seeing the way through. The economy is slowing. Inflation is coming down. So we do have a kind of Goldilocks combination of slowing inflation, slowing but still positive growth.

13:22Stocks are expensive, but they don't look bubbly per se. And I don't know. I just feel like there is a way through here. And I say, FI on your most negative predictions. I'm not super negative, but I do think that there is a possibility that the bond market is right for the wrong reasons in the sense that maybe there is something that looks and smells a lot more like a recession coming over the course of next year, in which case six rate cuts arguably would make sense. But again, maybe the stock market is not wrong either, but in the sense that, you know, everyone's been saying for as long as I've been in financial journalism, which is an alarmingly long time, that, you know, oh, well, any day now, the market's going to start rewarding companies based on their fundamentals, and it's going to be about earnings, and it's not going to be about just multiples.

14:16And it's like, it's multiples, guys. It's always multiples. Like, just because something is overvalued, it can stay there. I would say that the bond market, I agree with you, The short end has moved pretty dramatically. However, the long end, the 10-year Treasury is still at almost 4%. I think it's 3.9 % this morning. 3.9%. That is not necessarily a recessionary level. Yeah. Going to be an almighty battle next year between the Fed and the markets. And I am here for it. I'm sure you are too. But we are going to have to wrap it up there. We'll be back in a sec with Long Short.

15:04Okay, it's time for Long Short, the part of the show where we go long, a thing we love, short, a thing we hate. Rob, what you got? It's been a terrible year for fraud and deception. What, not enough of it? No, I mean, it's just been so unsuccessful this year. So we've had FTX and Sam Bankman freed, convicted, George Santos thrown out of the House of Representatives, something that was... He's good value, isn't he? Yes. The Nikola CEO was convicted of deceiving investors. A Vatican cardinal got convicted. it's been a very difficult year for fraud and deception. And so I think we're going to revert to the mean and I'm going to go long fraud for 2024.

15:56I think it's going to be a great year for cheats and liars in 2024. And getting away with it. For getting away with it. Rudy Giuliani too,$148 million. I mean, what is a liar to do in today's world. Difficult times. I am short. I don't I don't hate them, but I'm short of them. Christmas cards. What has happened to Christmas cards? I used to get lots of Christmas cards. Either I'm suddenly very unpopular, which is definitely possible, or people are not sending them anymore. And I think people are not sending them anymore. And I know this because I haven't received one from my grandmother. Oh, and like, have you considered the fact that she just doesn't love you anymore, Katie?

16:38It's definitely possible. But, you know, in fairness, she's 100 years old. Hello, Grandma. Happy Christmas. I don't think she listens to the show. But maybe when you're 100, you don't bother writing Christmas cards anymore. But normally, by like the 5th of December, I've got one from Grandma, and I haven't got one this year. So I think people are just not sending them anymore. My mental is bare as well. So decline in moral values and or my levels of popularity with my own family. So, yeah, sure, Christmas cards. They had a good run. But it seems like they're kind of over. We, as a beautiful segue, are over for today.

17:16Rob, it's been a pleasure. And we will catch up again, no doubt, very soon. Unhedged is produced by Jake Harper and edited by Brian Erschlap. Our executive producer is Jacob Goldstein. We had additional help from Topher Forheads. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, Jacob Weisberg and Jess Trulian. FT Premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available for everyone else. Just go to ft.com slash unhedged offer. I'm Katie Martin. Thanks for listening.

18:08rubbed