Bear market rallies are known to be quick and harsh. We have now quickly rallied back up to the high end of the range we have been enmeshed in for the better part of two years. They say, “Don’t fight the Fed.” The Financial Conditions Index (FCI) is a weekly update on U.S. financial conditions in money markets, debt and equity markets, and the traditional and “shadow” banking systems. Understand that tighter conditions mean the Fed might lower interest rates to support the economy and financial assets. A decline in the FCI means the Fed may seek to raise rates to slow things down.
The massive surge in stocks and bonds over the last two weeks prompted one of the most significant declines in financial conditions in the last few years. The easier conditions have erased all of 2023’s “tightening” by the Fed. The new highs in the market have effectively put us back at the same level as when Fed funds were 150bps lower. They are calling it the FCI doom loop. The higher the market goes, the more the Fed will need to tighten. Round and round we go. Higher stock prices are “fighting the Fed”.
The end result of the FCI doom loop is a range-bound market that can’t get too hot or too cold but must stay just right, or the Fed will intervene.
This is what we said last week, and it still holds true: We have no desire to chase as we see the next decade running lower investment returns. Playing the bottom and top of ranges may go a long way to increasing our returns. Stay patient. Stay nimble. Do all the little things right, like managing our cash. Don’t chase.
The rally this week was because so many were underinvested and were forced to buy. The other impetus (FOMO) was the end-of-the-year rally which is very much feared by those under-invested or short. We said we were going to have to be nimble… I don’t want to chase but mid-month we should see some pullback. 2024 is going to be another story.
Next week, we could see some pullback, as the options expiration in November was quite significant. I am not saying that it will pull back, but it has potential due to the unlocking of the options market in the post-expiration period. The animal spirits are alive and well here, as there is a palpable fear of missing out on the Santa Claus rally. Seasonality in the market is something to be aware of, not trade on, but there seems to be many people betting on it this year.
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