Ameriprise Financial : Stars Align to Kick Market Rally Into New Gear At Year-End

Stars Align to Kick Market Rally Into New Gear At Year-End

12/18/2023

Anthony Saglimbene, Chief Market Strategist, Ameriprise Financial

The S&P 500 Index and NASDAQ Composite each finished their seventh straight week higher and continue to put an exclamation point on a strong year of performance in the final weeks of 2023. For the S&P 500 Index, the current winning streak is its longest since 2017. Notably, the Dow Jones Industrials Average recorded its ninth straight week of gains, putting in its longest consecutive weekly winning streak since 2019.The S&P 500 Index and NASDAQ Composite each finished their seventh straight week higher and continue to put an exclamation point on a strong year of performance in the final weeks of 2023. For the S&P 500 Index, the current winning streak is its longest since 2017. Notably, the Dow Jones Industrials Average recorded its ninth straight week of gains, putting in its longest consecutive weekly winning streak since 2019.

Outside of stocks, Treasury prices were firmer across the curve last week as yields sank. The U.S. Dollar Index weakened across the major currencies, while Gold finished higher by less than +1.0%. West Texas Intermediate (WTI) crude rose slightly during the week, ending seven consecutive weeks of decline.

Market rallies into year-end

Frankly, the setup for December couldn't have gone better even if it had been scripted by a Hollywood director who had backend residuals based on the performance of U.S. stock prices. Simply, recent updates on macroeconomic conditions over the last handful of days are helping this year's market rally broaden to areas outside mega-cap Tech. In December, Real Estate, Industrials, and Financials are more prominently helping the S&P 500 add to its already strong year-to-date gains, while the Russell 2000 Index is higher by nearly +10.0% in December and outperforming the S&P 500 by an impressive 640 basis points month-to-date. All of these areas have been significant performance laggards for most of the year.

Key to keeping stock momentum grinding higher last week were key inflation updates and dovish takeaways from the Federal Reserve's last meeting of the year. The Dow hit a new all-time high on Thursday, while the S&P 500 is currently less than +2.0% away from hitting its all-time high, last seen in early January 2022. While November consumer price inflation came in a bit hotter than expected on a headline basis, the overall release was generally in line with expectations. In addition, November producer price inflation came in largely flat month-over-month, with the annualized rate of increase the smallest in three years. Bottom line: Inflation remained on its downward trajectory last month, and expectations and data suggest that the trend is likely to continue into 2024.

Fed takes a more dovish stance

But the most notable item of the week that had the greatest influence on sending stock prices higher was the unexpectedly dovish tones coming out of Fed Chair Jerome Powell and company. As expected, the Federal Reserve left its fed funds target range unchanged at 5.25% to 5.50% last week. That marked the third straight meeting in which policymakers decided to leave the target rate unchanged. In the policy statement, the Fed acknowledged that inflation has eased over the past year, and the Fed will be data-dependent in determining the extent of "any" additional policy firming. Notably, in the previous statement, policymakers had referred to inflation as "elevated." In our view, the addition of the word "any" in the updated policy statement also suggests the central bank believes current rates could already be at the highwater mark for this cycle, which Fed Chair Powell helped clarify in his press conference. While not much else changed in the Fed's statement, the slight language shift on inflation and lower probability of additional rate hikes were quickly perceived by the market as a subtle shift to a more dovish stance and without having to walk back the possibility of further rate hikes if necessary.

Importantly, the December Summary of Economic Projections now forecasts roughly three 25-basis point cuts in the fed funds target rate in 2024. That's one more 25 basis point cut than what was forecast in September. As we have noted previously, a projection of additional rate cuts in 2024 above September's forecast would likely be greeted positively by the stock market. Last week's market reaction helps confirm that view. As a result, nearly 70% of the market currently sees the fed funds rate heading lower in March.

Interestingly, Mr. Powell insinuated that the committee would be sensitive to cutting rates if conditions warrant and possibly before core inflation hits 2.0%. That's a key takeaway for investors from our point of view and helps further keep the soft-landing scenario in play. While the Fed will need to be confident that inflation will move to 2.0% and stay there, it may start to act with gradual easing before inflation hits the target and if it sees growth slowing more significantly. Engineering a soft landing for a $28 trillion economy simply on the level of policy rates is a tall order. However, a pragmatic policy approach, and one that encompasses a host of economic measures and is sensitive to the delayed effects in some components of core inflation (i.e., shelter costs), is likely necessary to achieve that soft landing. Stocks and bonds rallied last week because it appears that Mr. Powell and company fully understand that point. Importantly, we believe the Fed took a critical step last week to recognize and communicate that as long as inflation moderates as expected next year, it has room to lower policy rates and will likely do so. That's the message investors have been waiting on for the last few meetings, and in our view, Mr. Powell finally delivered that message more prominently than previously stated.

Bottom line: Solid employment trends, moderating inflation, declining interest rates, and some dovish tones from the Federal Reserve all helped align the stars this month, kicking the stock market rally into a new gear during the final weeks of 2023. That said, January tends to be a volatile month both to the upside and downside. Market odds now suggest aggressive rate cuts next year, which seem somewhat inconsistent with a soft-landing scenario. At the same time, core inflation remains elevated, and rate cuts, as Fed Chair Powell stated last week, are contingent on the committee's confidence that inflation will trend toward target. However, all the "ifs" and "buts" regarding the macro environment can be debated in the new year. For now, investors see odds of a soft landing for the economy improving, which can contribute to corporate profits improving for a broader set of industries, which could dovetail into higher stock prices next year, particularly for some of this year's laggards. In a nutshell, that's our base case scenario for next year. The question, however, is how much of that scenario is building into stock prices today, given the stock market's strong rally in November and December. But as we note in our 2024 Outlook reports, the environment is starting to look a lot more normal than it has over recent years, which argues for getting back to basics on portfolio construction and taking advantage of opportunities in bonds, high-quality stocks, and cyclical areas that may have a chance to outperform in 2024.

The 2024 outlook

We see financial conditions in the U.S. continuing to normalize after several years of extremes. Given the right circumstances, areas across Europe and Asia may also see increased economic stabilization in 2024. Key items to watch center around evolving monetary policies, the direction of interest rates, trends in global growth, and whether corporate profits can maintain a positive trajectory. In our view, several developed world central banks now have room to lower policy rates to help support economic activity should growth slow more than expected, particularly if inflation moderates back to target as we expect.

However, the delayed effects of prior aggressive rate hikes, elevated core inflation, and higher borrowing costs leave the investment landscape fragile and susceptible to risk if the U.S. is not able to avoid a shallow downturn. That said, we believe interest rate pressures should moderate, U.S. consumer and business balance sheets should remain firm, and several areas of the stock market look attractive. In our view, this leaves room for longer-term investment opportunities if investors can look through a potential period of volatility should conditions deteriorate more than we expect.

And while 2024 is a U.S. presidential election year, which will come with outsized noise later in the year, a continuation of divided government may be a welcomed outcome, at least over the short term. Importantly, investors should maintain a pragmatic and flexible investment approach at the start of 2024 and lean into diversification strategies, which should see their correlation benefits return after a few difficult years.

Bottom line: In a world where growth remains positive, inflation is moderating back to normalized levels, and interest rates are stabilizing and possibly even heading lower, stock and bond prices have an opportunity to perform well in 2024. And while risks of a shallow downturn remain present, the pressures of inflation and rapidly rising interest rates have run their course, in our view. Just as the sharp upswing in interest rates was a strong headwind for economic activity and financial market results in the last two years, we believe falling rates should offer solid support to business activity and financial market performance in the quarters ahead. And should conditions potentially evolve into a shallow downturn, strong consumer and business balance sheets and the themes and strategies outlined in our 2024 Outlook reports should help investors navigate such conditions with confidence.

For further information on the trends we see shaping the year ahead, including themes and strategies that can help investors navigate a still complex environment, please ask your Ameriprise financial advisor for our 2024 Outlook and Themes reports.

Our Weekly Market Perspectives report will return on January 8, 2024. From everyone at Ameriprise Financial, have a safe and memorable holiday season with family and friends.

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