LD Capital Weekly Powell’s Unexpected Dovish Stance Sparks Radical Repricing in the Market

LD Capital's Weekly Report Powell's Surprising Dovish Approach Causes Significant Market Repositioning

Source: LD Capital

The following chart is the most important chart of the week. FOMC members “collectively shifted”, and it can be said that the Fed’s December meeting released the clearest signal of a rate cut, with a 75bp cut that exceeded market expectations. After that, everything from stocks to bonds, non-US currencies to commodities, everything went up, but cryptocurrencies lagged behind this time.

Because on December 1st, Powell warned the market that “guessing when to start easing now is too early”, but in the news release on December 13th, he stated “starting to discuss the issue of rate cuts”. So this dovish shift exceeded market expectations. Last week, the Dow Jones, the Nasdaq 100, and the S&P 500 all hit new historical highs, with the Russell 2000, representing small caps, skyrocketing 5.7% and still more than 15% away from its historical high.

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Market risk appetite further strengthened:

Funds are quickly restoring valuations for real estate, consumer goods, and industrial stocks, and it seems that there is still room to go:

The US-China Internet Index, HXC, rose by 3% despite A shares falling for the sixth consecutive week;

The yield on US 30-year Treasury bonds fell below the key level of 4% last week, dropping from a multi-year high of 5.18% in October, and the yield on 10-year Treasury bonds fell below the level of 3.9%. Williams and Bostic dampened the enthusiasm of the market on Friday, but the market adjustment was extremely limited, highlighting that the Pivot narrative is still ongoing.

The derivatives market has already bet that benchmark interest rates will drop to a level as low as 3.9% next year and start cutting rates in March. This is much lower than the 4.6% interest rate level shown by the Fed’s dot plot. Considering the healthy or even overheating indicators such as the momentum of the US economy, the performance of the financial market, the performance of the job market, the default rate of commercial loans (1.33%), and the default rate of credit (90D 1.3%), apart from inflation approaching the target, we can’t see any reason for the Fed to hurry up and cut interest rates three months from now.

Moreover, the first rate cut cannot be regarded as a real relaxation of monetary policy. It is a preventive adjustment made under the condition that the pressure on prices is greatly relieved, and the overall restriction level is still maintained. If the economic growth performance exceeds the Fed’s target of 1.5% next year, the actual space for rate cuts may be extremely limited.

It seems that there is no further room for optimistic pricing, which may be a good short-term profit-taking point for bond bulls. For the stock market, there may still be some room for growth, mainly considering the favorable macro background, mainly the Fed and the US economy have just reached a very friendly position. Secondly, there are seasonal factors and fund flows, which are still in a favorable situation.

However, the overall tone of the Fed last week is still more dovish than the ECB. For example, Madis Muller, a member of the ECB’s Governing Council, said on Friday that the market is ahead of them in betting that the ECB will start cutting interest rates in the first half of next year. On Thursday, ECB President Lagarde said that the bank had not even discussed cutting interest rates.

Major institutions have also lowered their forecasts for US bond yield curves after the meeting. Barclays has lowered its forecast for the 10-year US Treasury yield at the end of 2024 from 4.5% to 4.35%, Goldman Sachs from 4.3% to 4%, and JPMorgan Chase from 4.3% to 3.65%. We also saw Goldman Sachs raise its year-end target for the SPX by a significant 8% to 5100.

Bank of America predicts 152 rate cuts by global central banks next year:

Jefferies: Overbought

Based on the 14-day RSI, 49% of 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 has only happened once since 1990. This situation may be driven by a lot of market stop-loss orders. It usually also marks a turning point in the market, and the market may enter a cooling-off period:

Historical data:

• 1-month performance: When more than 30% of stocks in the SPX are overheated, the average performance for the next month drops by 1.14% (negative 114 basis points), and 53% of the time is negative.

• 3-month performance: The average performance over three months is usually stable, with no significant ups or downs.

• 12-month performance: Looking ahead 12 months, the average performance is a positive 12% increase, and in 95% of cases, it is positive.

Largest outflow from money market funds since October

As of the week ending December 13th, approximately $11.6 billion flowed out of US money 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.

Investors have injected $1.4 trillion into money market funds this year, while US stock funds have only received $95 billion in inflows, a significant disparity.

Money market fund assets have fallen from historical highs before the quarterly tax day, which may indicate a shift in funds as the prospect of interest rate cuts next year prompts investors to seek higher returns in other assets.

However, according to Bank of America Merrill Lynch’s analysis, the large-scale continuous inflow of money market fund funds into risk asset markets may have to wait until the fourth quarter of next year, and historically, it has mostly been triggered by the end of an economic recession:

In the past four cycles, money market fund inflows have 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 the inflows could continue until September 2024.

Since 1990, money market fund outflows have started an average of 12 months after the first interest rate cut, and if this trend continues, the outflows will start in the first quarter of 2025.

Since 1990, all money market fund withdrawal events have been triggered by the end of an economic recession, except for the soft landing period in 2019, when no outflows occurred.

In the past five cycles, money market fund outflows have been equivalent to 20% of the previous inflows, which means that approximately $250 billion in cash will be deployed into risk assets, expected to begin in the fourth quarter of 2024 or the first quarter of 2025.

Fund Flow and Positions

Deutsche Bank’s total equity position measure rose again this week, further entering the overweight range (z-score 0.46, 70th percentile), high but not yet extreme.

Among them, the position level of self-directed strategy investors is at the 86th percentile, while systematic strategy is only at the 51st percentile.

The funds flowing into equity funds ($25.3 billion) have also soared to the highest point 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 the 39th percentile:

Bank of America’s quantitative tracking believes that the current CTA funds’ long positions on the Nasdaq and S&P have been excessive, further buying pressure is limited. However, the momentum of small-cap stocks is expected to be supported in the coming week:

Goldman Sachs client trading data shows that the total leverage ratio rose by 2.4 percentage points to 199.1% (100th percentile in three years of history), the net leverage ratio increased by 0.9 percentage points to 54.6% (48th percentile), and the overall long/short ratio increased by 0.2% to 1.755 (25th percentile):

The U.S. Treasury bond funds have seen the largest outflows in the past two weeks since June 2020, despite the recent sharp rise in U.S. bond prices, indicating that early investors may be cashing out:

Sentiment

The Bank of America Bull/Bear Indicator has reached its highest level since the start of the bull market 14 months ago, although it is far from the extreme sell-off zone:

Goldman Sachs’ sentiment indicator has been at an “excessive” level for the fifth consecutive week:

AAII investor survey sees the bullish sentiment ratio reaching its highest level since July 20th,

CNN Fear & Greed Index slightly increased and is in the greedy (>70) range, but has not reached extreme greed:

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