There are times when the outlook for the stock market is complicated. There are other times when getting a handle on the next move for stock prices is pretty simple…
Like back at the start of 2023, it was complicated. Inflation was running amok and the Fed was jacking interest rates at a record pace. There was a general consensus among big-name economists and strategists that the Fed would push the economy into recession. (Hammer and I often wrote about how reshoring and pandemic savings would spare the economy a recession, but that’s a different story).
Things got simple again in October of 2023 when the Fed said it was done hiking interest rates. The S&P rallied in practically a straight line and was 27% higher in March 2024.
The pendulum swung back to complicated in mid-July when the unemployment rate spiked to 4.3%. It seemed the Fed was once again behind the curve. Recession was back on the menu. There was even a quick 10% correction for stock prices!
It’s pretty likely that the stock market outlook for the rest of the year is about as simple as it gets…
Don’t Fight the Fed
The Fed is now pumping liquidity into the economy. And liquidity always finds its way into the stock market.
What’s more, if it turns out that the Fed actually is a little behind the curve on unemployment, don’t worry, the so-called “Fed put” is back, baby!
If you don’t know, a put option is an options contract you can buy to own through any broker. The value of a put option goes up when the underlying asset of the put option falls in value. If your goal is to make money (and I hope it is) a put option literally means that bad news is good news…
Like if you think there might (for some mysterious reason!) be bad news coming for Boeing, you could buy a put option whose value will rise when bad news sends Boeing’s share price lower.
The Fed put works exactly the same way. Now that the Fed is committed to fighting unemployment, if we do get bad unemployment news, it just means the Fed will be even more aggressive with rate cuts. More liquidity = higher stock prices. It is as simple as that…
So we are likely to get one of those “melt-ups” for stocks for the balance of 2024.
Because the simple fact is, it’s not just the Fed that is pumping the liquidity. China has unleashed a flood of liquidity into its economy. It’s cut deposit requirements at banks, lowered downpayment requirements for real estate purchases, cut lending rates, and let the yen weaken – it is even requiring banks to lower the interest rates on existing mortgages to put money into people’s pockets. Chinese stocks have responded with one of the sharpest sector rallies I’ve ever seen.
And it’s not just the U.S. and China – the EU, Canada, Switzerland, Sweden, Brazil and New Zealand have all cut rates. Norway and Japan are holdouts, but they’ll probably join the party soon enough.
What Could Go Wrong
Now if you want to make things complicated, you could point out that the Fed is opening the liquidity pumps while the stock market is at all-time. And that is unusual for sure…
And it is absolutely worthwhile to dig into why the Fed is acting this way.
For one thing, there’s the outrageous amount of interest that the government is paying for the debt it has run up. Lowering those payments is fiscally smart (so is cutting deficit spending so we don’t incur such interest liability in the first place, but that also appears to be another story).
A bigger concern is that maybe the Fed knows it is behind the curve on unemployment and the recent jumbo interest rate cut was a bit of a panic move. That’s possible, maybe even likely. At the same time, it will take more than one month of worsening data to shake the faith that the Fed put can save the day.
The biggest concern might be China. If the Fed’s rate cut response to rising unemployment can be considered a bit of a panic move, I’m not sure there are strong enough words to describe the Chinese government response to its own looming economic disaster…
Now that China’s population is declining, no stimulus can truly fix its economy. The best that can be hoped for is to buy time and hope that some other solutions can be implemented.
Ultimately, I think that’s all China’s moves over the last week will do — buy some time.
How much time? Well that’s the big question isn’t it.
The last time China opened the liquidity pumps like this was coming out of the Great Financial Crisis. The effect was a massive rally for commodities that lasted for a couple years. But the world was coming out of the GFC and stocks were coming off the extremely low levels.
That’s not the case now. U.S. stocks are at record highs. China’s the only major economy with a stock market that might be called undervalued.
A melt-up now will take U.S. valuations to extreme levels pretty quick. That’s why I’m only willing to bet on things being simple through the end of the year.
Cheers,
Briton Ryle
Chief Investment Strategist
Outsider Club
X/Twitter: https://twitter.com/BritonRyle
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Fed and Unemployment
