LD Capital Weekly Macro Report (12.18): Powell's unexpected dovish sentiment led to aggressive repricing in the market

The chart above is the most important chart of the week, with the FOMC members “turning en masse” and arguably giving the clearest signal of a rate cut so far from the Fed’s December meeting, with a 75 bp drop that also exceeded market expectations, after which everything from stocks to bonds, non-US currencies to commodities was on the rise, but cryptocurrencies lagged this time.

Because on 1 December, Powell also warned the market that “it’s too early to guess when to start easing”, and on 13 December, he said that “the issue of rate cuts is starting to be discussed”, so this dovish turn was beyond market expectations, with the Dow and Nasdaq 100 hitting record highs last week, and the S&P 500 just one step away from all-time highs. The small-cap represents the Russell 2000, which jumped 5.7% last week and is still more than 15% away from its all-time high.

Market risk appetite has strengthened further and substantially:

Funds are making rapid valuation repairs to real estate, consumer discretionaries, and industrial stocks, and there seems to be room for this:

The U.S. China Concept Index HXC rose 3%, although A closed lower for the sixth consecutive week;

The US 30-year Treasury yield fell below the 4% mark last week from a multi-year high of 5.18% in October, and the 10-year fell below the 3.9% mark. Williams and Bostic dampened some of the market’s enthusiasm on Friday, but the market correction was extremely limited, highlighting the fact that the pivot narrative is still ongoing.

The derivatives market has already bet on an annual benchmark interest rate as low as 3.9% and started cutting rates in March. This is well below the 4.6% interest rate level shown by the Fed’s dot plot. Considering that the economic momentum of the United States, the performance of the financial market, the performance of the job market, the default rate of commercial loans (1.33%), the credit default rate (90 D 1.3%) and other indicators are all in a healthy or even overheated range, except that inflation is approaching the target, we do not see the reason why the Fed will cut interest rates in a hurry after three months.

Moreover, the first interest rate cut cannot be regarded as a real easing of monetary policy, but a precautionary adjustment is made in the case of a significant easing of price pressures, and the overall level of restrictions is still maintained, and if the economic growth performance next year is higher than the Fed’s 1.5% target, the actual room for interest rate cuts may be extremely limited.

The room for further optimism seems to have come to an end, and it could be a pretty good short-term take-profit point for bond bulls. For the equity market, there may still be some upside, mainly given the favourable macro backdrop, mainly the fact that a very friendly position has just been reached between the Fed and US economic growth, and secondly, seasonality and capital flows, which remain in a favourable situation.

But the overall Fed’s tone last week was still more dovish than the ECB’s, for example: ECB Governing Council member Madis Muller said on Friday that markets are ahead of their bets that the ECB will start cutting interest rates in the first half of next year. On Thursday, ECB President Christine Lagarde said that the bank had not discussed a rate cut at all.

After the meeting, major institutions also lowered their U.S. yield curve forecasts, with Barclays falling from 4.5% to 4.35% for 10 Y U.S. Treasuries at the end of 24, Goldman Sachs from 4.3% to 4%, and JPMorgan Chase from 4.3% to 3.65%. We’ve also seen Goldman Sachs directly raise its SPX price target by 8% to 5100 by the end of next year

BofA predicts 152 rate cuts by global central banks next year:

Jefferies: Heavily overbought

According to the 14-day RSI, 49% of stocks in the S&P 500 are considered overbought (>70). It’s rare for more than 50% of stocks on the SPX to overheat. This has only happened once since 1990. This situation may be driven by a number of market stop-loss orders. It also usually marks a turning point in the market, where the market may enter a cooling-off period:

Historical Data:

• 1-Month Performance: When stocks with SPX over 30% overheated, the average one-month performance dropped by 1.14% (minus 114 basis points) and was negative 53% of the time.
• 3-month performance: The three-month average performance is generally smooth, with no significant ups and downs.
• 12-Month Performance: Looking forward 12 months, the average performance is a positive 12% growth and 95% of the time is positive.

Money market fund assets retreated for the first time since October

About $11.6 billion flowed out of U.S. money market funds in the week ended Dec. 13. Total assets fell to $5.886 trillion from $5.898 trillion in the previous week, the first net outflow in eight weeks.

Investors have pumped $1.4 trillion into money market funds this year, while U.S. equity funds have received only $95 billion in inflows, a huge disparity

Money market fund assets falling from record highs before the quarterly tax day could signal a shift in flows, as the prospect of interest rate cuts next year prompts investors to seek higher returns on other assets.

However, according to Bank of America Merrill Lynch’s analysis, the large-scale and sustained inflow of money market funds into the risk asset market may not wait until the fourth quarter of next year, and most of them have historically been triggered by the end of the recession:

Over 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 inflow is likely to continue until September 2024.

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

Since 1990, all money market fund divestments have been triggered by the end of the recession, with the only exception being during the soft landing in 2019, when no outflows occurred.

Over the past five cycles, money market funds have seen outflows equivalent to 20% of previous inflows, meaning that approximately $250 billion of cash will be deployed into risky assets, which is expected to begin in the fourth quarter of 2024 or the first quarter of 2025.

Money Flow and Positions

Deutsche Bank’s measure of total equity position rose again this week, moving further into overweight territory (z-score 0.46, 70th percentile), high, but not extreme

Among them, the position level of investors in independent strategies is in the 86th percentile, and the position level of systematic strategies is only in the 51st percentile

Inflows into equity funds ($25.3 billion) also surged to their highest point in nearly 21 months, led by the United States ($25.9 billion), with the largest increase in emerging market equities:

The allocation of CTA funds to equities has finally returned to the normal range and is currently trading at the 39th percentile:

BofA’s quantitative tracker believes that CTA funds have overdone long positions in the Nasdaq and S&P for now, limiting further buying, although momentum in small-cap stocks is still expected to be supported in the coming week:

Goldman Sachs client trading data, total leverage rose 2.4 percentage points to 199.1% (100th percentile in three-year history) and net leverage rose 0.9 percentage points to 54.6% (48th percentile) The overall long/short ratio rose 0.2% to 1.755 (25th percentile):

Treasury funds saw their biggest two-week outflows since June 2020, and despite the recent rally in Treasuries, it could be seen that the funds that entered the market first may be cashing in:

Emotions

The Bank of America CBBS indicator reached its highest level since the start of the bull market 14 months ago, although it is far from reaching the extreme selling zone:

For the fifth week in a row, Goldman Sachs’ sentiment indicator is at the “excessive” level:

AAII Investor Survey Bullish Percentage Rises to Highest Since July 20,

The CNN Fear and Greed Index edged higher and was in the >70 greed range, but did not touch extreme greed