LD Capital Macro Weekly Report (12.18) Powell’s unexpectedly dovish stance triggers a radical repricing in the market
Surprising Dovish Stance from Powell Causes Radical Market Repricing LD Capital's Macro Weekly Report (12.18)The above chart is the most important chart of the week. FOMC members have “collectively turned,” and it can be said that the December Fed meeting has released the clearest interest rate cut signal so far. The 75 basis point reduction exceeds market expectations. Afterwards, everything from stocks to bonds, non-US currencies to commodities, has been rising, but cryptocurrencies have lagged behind this time.
This dovish turn is beyond market expectations because on December 1st, Powell warned the market, “It’s too early to guess when to start easing,” but on the news release on December 13th, he said “the issue of starting the discussion on interest rate cuts,” so this dovish turn is unexpected. Last week, the Dow Jones Industrial Average and the Nasdaq 100 both hit historical highs, while the S&P 500 is just a step away from its record high. The small-cap representative Russell 2000 index rose sharply last week, up 5.7% and still more than 15% away from its all-time high.
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Market risk appetite further strengthened significantly:
Funds are rapidly revaluing real estate, consumer discretionary goods, and industrial stocks, and it seems that there is still room:
The US-listed Chinese stock index HXC rose by 3%, despite A shares falling for the sixth consecutive week;
The yield of US 30-year Treasury bonds fell below the key level of 4% last week from a multi-year high of 5.18% in October, and the 10-year yield fell below the 3.9% mark. Williams and Bostic suppressed some enthusiasm in the market on Friday, but the market correction was extremely limited, highlighting that the pivot narrative is still ongoing.
The derivatives market has bet that the benchmark interest rate will be as low as 3.9% next year and will start cutting rates in March. This is much lower than the 4.6% interest rate level shown by the Fed’s dot plot. Considering indicators such as the economic momentum in the United States, financial market performance, employment market performance, commercial loan default rate (1.33%), credit default rate (90D 1.3%), etc., are all in the healthy or even overheated range, and except for inflation approaching the target, we do not see the reason for the Fed to rush rate cuts three months later.
And the first interest rate cut cannot be considered a true relaxation of monetary policy, but rather a preventive adjustment in the case of significant alleviation of inflationary pressures, overall maintaining restrictive levels. If next year’s economic growth performance exceeds the Fed’s target of 1.5%, the actual room for interest rate cuts may be extremely limited.
It seems that the space for further optimistic pricing may have reached its limit, which could be a good short-term profit-taking point for bond bulls. As for the stock market, there may still be some room for further growth, mainly due to favorable macroeconomic conditions, especially the very friendly positioning between the Federal Reserve and US economic growth. Additionally, favorable seasonal and fund flows are still in play.
However, the overall tone of the Federal Reserve last week was more dovish than the European Central Bank. For example, Madis Muller, a committee member of the European Central Bank, said on Friday that the market is betting ahead of them that the ECB will begin cutting interest rates in the first half of next year. On Thursday, ECB President Lagarde stated that the bank has not even discussed interest rate cuts.
After the meetings, major institutions have also downwardly adjusted their US bond yield curve forecasts. Barclays lowered its forecast for the 10-year US bond yield from 4.5% to 4.35%, Goldman Sachs lowered it from 4.3% to 4%, and JPMorgan Chase lowered it from 4.3% to 3.65%. We also saw Goldman Sachs directly raise its year-end target price for the S&P 500 Index by a significant 8% to 5100.
Bank of America forecasts 152 interest rate cuts by global central banks next year:
Jefferies: Severe Overbuying
Based on the 14-day RSI, 49% of the stocks in the S&P 500 Index are considered overbought (>70). It is rare for over 50% of stocks in the SPX to be overheated. This situation has only occurred once since 1990. This situation may be driven by a significant number of market stop loss orders. It usually also signals a turning point in the market, and the market may enter a cooling-off period:
Historical Data:
- 1-month performance: After more than 30% of SPX stocks become overheated, the average one-month performance decreases by 1.14% (negative 114 basis points), and 53% of the time it is negative.
- 3-month performance: The average performance over three months is usually stable, with no significant gains or losses.
- 12-month performance: Looking ahead 12 months, the average performance is a positive 12% growth, positive in 95% of cases.
Currency Market Fund Assets Fall for the First Time Since October
As of the week ending December 13, approximately $11.6 billion flowed out of US currency market funds. Total assets decreased from $5.898 trillion in the previous week to $5.886 trillion, marking the first net outflow in 8 weeks.
This year, investors have injected $1.4 trillion into currency market funds, while US stock funds only received $95 billion in inflows, highlighting a significant disparity.
The decline in currency market fund assets, even before the quarterly tax day, may indicate a shift in capital flows as the prospect of interest rate cuts next year prompts investors to seek higher returns from other assets.
However, according to analysis from Bank of America Merrill Lynch, the large-scale inflow of funds from currency funds into risky asset markets may have to wait until the fourth quarter of next year, and historically, this has mostly been triggered by the end of an economic downturn:
In the past four cycles, the inflow of funds into currency market funds has continued for an average of 14 months after the last Fed rate hike. Considering that the last rate hike was in July 2023, this means that fund inflows could persist until September 2024.
Since 1990, the outflow of funds from currency market funds has typically begun 12 months after the first rate cut. If this trend continues, fund outflows could start in the first quarter of 2025.
Since 1990, all instances of fund withdrawals from currency market funds have been triggered by the end of an economic downturn, with the exception of the period of a soft landing in 2019, where no fund outflows occurred.
In the past five cycles, the amount of fund outflows from currency market funds has been equivalent to 20% of the previous inflows. This means that approximately $250 billion in cash will be deployed into risky assets, expected to start from the fourth quarter of 2024 or the first quarter of 2025.
Capital Flows and Positions
Deutsche Bank’s total equity position metric rose again this week, further entering the overweight zone (z-score 0.46, 70th percentile), high, but not yet extreme.
Among autonomous strategy investors, the position level is at 86th percentile, while systematic strategies are only at the 51st percentile.
Funds flowing into stock funds ($25.3 billion) have also soared to the highest level in nearly 21 months, led by the United States ($25.9 billion), with the largest growth rate in emerging market stock markets:
CTA funds’ allocation to stocks has finally returned to the normal range, currently reporting at the 39th percentile:
Bank of America’s quantitative tracking indicates that CTA funds have already become overly bullish on the Nasdaq and S&P, limiting further buying activity. However, small-cap stocks are still expected to receive support in the coming week:
Goldman Sachs’ client trading data shows that the total leverage ratio rose by 2.4 percentage points last week to 199.1% (the 100th percentile in the three-year history), while the net leverage ratio increased by 0.9 percentage points to 54.6% (the 48th percentile). The overall long/short ratio rose by 0.2% to 1.755 (the 25th percentile):
US Treasury fund experienced the largest two-week outflow since June 2020, despite the recent surge in US bonds, suggesting that early investors may be cashing in:
Sentiment
Bank of America’s bull and bear indicator reached its highest level since the start of the bull market 14 months ago, although it has not yet reached the extreme sell-off area:
Goldman Sachs’ sentiment indicator has been at “excessive” levels for the fifth consecutive week:
AAII investor sentiment survey sees the bull ratio rise to the highest level since July 20th,
CNN Fear & Greed Index slightly increases, remaining in the greed zone (>70) but not reaching extreme greed.
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