Bull market tested as volatility spikes, overheated assets cool off. The testing may not be done
A turbulent week on Wall Street ends with a “Thank Goolsbee, it’s Friday” rally, after the Chicago Fed President used a CNBC appearance to refocus investors’ attention on the still-encouraging trend in inflation and the likelihood that interest rates still have room to be trimmed in the context of a healthy economy. Friday’s 1.1% relief bounce in the S & P 500 also owed plenty to the tame PCE inflation reading that morning, not to mention the preconditions of a rather washed-out stock market following three weeks of oppressive sub-surface selling pressure. Neither Austan Goolsbee’s predictably soothing words nor the Friday index rebound were enough to offset fully the quicksilver repricing of Federal Reserve’s rate-setting path for next year, nor the 3% dump in the S & P 500 on Wednesday that followed the Fed’s decision and outlook release. Yet in a few respects, a bit of wobbly action in the indexes, surge in volatility and reversals in some of the more overheated assets were overdue and probably necessary to test the bull market against higher bond yields and a more-foggy policy horizon. And who’s to say the testing process is complete? .SPX YTD mountain S & P 500, YTD The market entered December on a high, brimming with certainty about a favorable outlook based on prevailing market uptrends, an orderly Fed easing seasonal campaign, seasonal tailwinds and whatever policy outcomes an investor chose to assume will take shape next year. Strategists were lining up with bullish unanimity with their 2025 index targets and geysers of froth were blowing through crypto, thematic Trump-aligned Big Tech and low-quality/high-beta speculative stuff. Corrective action has reached these groups to varying degrees, the likes of MicroStrategy down by a third in the past month, though it’s impossible to say a proper purge has occurred there. MSTR 1M mountain MicroStrategy, 1 month The divergences inside the market got stretched to the point of brittleness, and the steady rise in Treasury yields alongside a rollover in the economic-surprise indexes made for an uneasy setup for Fed Chair Jerome Powell delivering an indecisive and somewhat dissonant outlook for a “new phase” of wait-and-see. With these more gray-shaded circumstances, as Bespoke Investment Group put it, “the honeymoon for all that could go right turned to a reality check.” The somewhat reassuring news is that this reality is not a particularly worrisome one – not yet, anyway. U.S. GDP continues to track above long-term trend, 2025 corporate-profit-growth projections are holding up fine, credit conditions remain rock solid and no serious damage has been done to the longer-term bull trend. There was a Ghost of Christmas Past element to the market’s skid in the past week, conjuring for some the dark memory of December 2018. The steep slide that month came as Fed rhetoric was perceived as too hawkish for comfort, coinciding with concerns over tariff impacts. That selloff formed a crescendo just before Christmas, with some aggressive rebalancing of portfolios back into stocks, though it had started much earlier, in October. The current bout of pressure is less severe, as is the Fed’s message, which is merely that the central bank is feeling its way toward a neutral policy rate that’s not agreed upon except for the fact that it’s still below the current level. 2025 preview? Citi strategist Scott Chronert sums up the market’s latest wobble as a preview of an expected push-pull that might animate 2025: “From our perspective, a lot of this is pulling forward concerns we had for the first half of 2025, especially as it is occurring against a sentiment and valuation setup that leaves little room for error. We believe markets will have to work through a period of policy uncertainty before we can refocus on possible policy opportunities.” On a purely tactical basis, some worthwhile work seemingly was done last week. The S & P 500 retreated back to a check of levels seen the morning after Election Day and held there. The tape reassuringly did manage to respond to pervasive oversold conditions with an impressively broad bounce Friday. The Volatility Index chart now features a nice prominent peak, up above 27 and back to 18 in a few days, the picture of a fever spiking and then breaking. That said, negative market breadth has been severe enough, especially in economically sensitive sectors, that technical analysts view a fairly short window for it to improve before it starts to send more ominous macro messages. Treasuries didn’t rally much on Friday’s cool PCE inflation report , and real 10-year year rates (adjusting for market-based inflation rates) remain above 2%, a level that has historically restrained the economy and given equities pause. The housing sector seems indefinitely stuck if yields don’t fall quite a bit. The one-line story of this entire 26-month bull market is, “Inflation coming down faster than the economy has slowed.” With, admittedly, a massive boost from the ferocious arrival of AI investment that bridged the indexes over a broad lull in earnings growth. The Fed last week implied that the interplay of inflation and growth from this point out is a bit less clear, and less clearly benign, while the fiscal-policy setup began to look more unruly than so many fund managers are suggesting in their year-end investor letters. The resolute bullish commentators like to point out that the current bull phase is not particularly mature, with the average duration of a post-1945 cyclical bull market (defined as the span between 20% or greater index declines) exceeding five years. True enough, but that average life is skewed higher by two unusually long advances, from 1987 to 2000 and from 2009 to 2020. Yet both of those extended bull cycles featured two 19% S & P 500 setbacks each (in 1990, 1998, 2011 and 2018), barely stopping short of a loss that would’ve punctuated them. A reminder, after two straight 20% up years that barely saw 10% corrections along the way, that the path to greatness is often a jagged and jarring one.
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