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Written by: Matt Lloyd | Advisor Asset Management
As we have previously stated, perhaps more than any time in history, we are in a confirmation bias-type market, but that is not due to the somewhat extreme levels seen in various markets, but rather the deluge of data and interpretations that are offered to the average investor. While data proliferation is more commonly associated with the logistics of storing it, this is easily transferred to the consumer who is attempting to digest the same data that would have historically been delivered over weeks or months and is now condensed into seconds.
So, that brings us to a more pertinent question, “Are the levels of the current markets exhibiting a more elegant efficient market pricing mechanism of future events or is it more bluntly apathetic?”
To address this in more detail, let’s consider what is priced in relative to other points in history. Perhaps most importantly for the markets is the gauge of inflation and interest rates and where expectations are in the immediate future and further down the road. Many have pointed to the large reduction in inflation from abnormal highs as progress and moving back to “normal.” Currently the Consumer Price Index (CPI) is running at 2.50% on a year-over-year basis while the Personal Consumption Expenditure (PCE) core index is running at 2.7%. The PCE number is cut nearly in half from its high and significantly lower than the 65-year average of 3.24%. CPI has fallen over 70% from its recent high and similar to the PCE, is off its 65-year average of 3.7%.
Expectations have moved from the accepted Federal Reserve target of 2.00% to 2.5–2.8% depending upon which measure one references. So, we still see expectations higher than where we are at now and higher than the commonly accepted rate for the Federal Reserve, but interest rates are pricing in a more benign market. Could inflation expectations be set for a surprise?
While not of the same metrics from the inflationary cycle of 1972–1983, the pattern has been eerily similar. As a byproduct of this elevated inflation level, more people need to work multiple jobs to make ends meet with September seeing the largest number of people in that category. As seen by the chart provided by the Federal Reserve, this has not been a good sign for the economy.
As inflation and expectations go, so to goes the interest rate projections. While the market got the 50bps (basis points) cut it wanted in September, the data has caused a shift in the expectations going forward.
The following two charts from Jim Bianco Research do a tremendous job of showing just how fluid interest rate projections are.
Source: Jim Bianco Research
When we compare the expectations of interest rate projections given by the Federal Reserve (aka the Dot Plot), we notice they have always been anchored around the 2–2.50% level going back to the initial hike in interest rates in 2021. Even the Federal Reserve has a baseline narrative that may not corroborate with history, but that’s what you get when you are trying to forecast a sense of calmness in a swirling wind environment.
At the max expectation, we were at nearly nine cuts being priced into the markets as evidenced by the chart below. However, this changed drastically as economic data came in stronger which caused expectations to become more timid, and why the 10-year Treasury yield has risen 40bps since September 16. However, consider that the chart below showed four fewer cuts next year, which equates to 100bps (4 x 25bps standard cut move). Does that mean the 10-year on a current level has another 60bps to move higher? Again, the debate of apathy or nuanced efficient market theory — which is more correct?
Source: Jim Bianco Research
When it comes to earnings, while they have been stronger than some of the expectations, as you can see, 2024 year-end have been coming down for some time. At the same time, the anchoring of 2025 earnings are not materially shifting. Some estimates are saying that we will need all-time highs on profit margins to attain the 2025 goals based on sales growth estimates. Watching conference calls on projected revenue, cost-cutting measures and layoffs will be instrumental to see how 2025 may come in to play.
While we have mixed data on the economic front, deciphering the current state of the markets causes a bit of consternation. We would assume that most investors, whether retail or institutional — and everywhere in between — would find the information in the market to confirm their current investment allocation. If you are skittish, you will be in too much cash; if you are not concerned, you may be allocated to heavy to more risky assets. With the increased data front and the variability in risk and volatility indexes combined with the last two decades of longer bull market runs, it is understandable why a level of apathy has set in for investors. One thing three decades in the industry has taught me, and often in a more brutal fashion, when one narrative is dominating the investment climate, it often means the blind spot is being marginalized. That said, the markets look to be following Isaac Newton’s first law in that an object in motion tends to stay in motion unless acted on by an external force.
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