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Separating Short-Term from Longer Term

December 05, 2023

I learned early in my career in trading that the end of the year, especially when it was a good year with solid returns, was “different.” I say that because once Thanksgiving came into view, market participants simply wanted the year to end quietly, with no surprises and solid gains. The net result is that markets tend to temporarily “ignore” any data or commentary that might jeopardize the gains (as long as it’s not too bad) and embrace any data or commentary that helps the bullish narrative into year-end. I think we are in the midst of that right now, and as such, barring a major negative surprise from the jobs report or next week’s Fed meeting, I’d not be surprised to see the S&P 500 drift sideways to modestly higher into year-end, almost regardless of headlines. 

However, as we look beyond the near term, there is an important issue developing, and I want to make sure we all properly understand it. The drop in Treasury yields has been precipitous. On Aug. 1, the 10-year yield was 4.03%. Over the next three months, it rose to a high of just over 5%. Then, in essentially five weeks, the 10-year yield has given back those three months of gains and now sits at 4.25%. Markets have aggressively embraced this decline in yields as signaling that the Fed will cut rates sooner than later and the cuts will be deeper than expected. That powered stocks higher in November. 

However, the sharp decline in yields could also be signaling something else: A slowdown in growth. Put more directly, why are yields falling so fast? Is the Fed really going to get that dovish? Or is the bond market pricing in a sudden slowing in growth? Or maybe the bond market is merely reacting to the end of interest rate increases by the Fed.

As we look forward to the start of 2024, when markets snap out of this “year-end” temporary fog, that question will be the most important facing investors. Right now, markets think the answer to that question is “Yields are signaling a dovish Fed and not a slowdown.” If that answer starts to shift in early 2024 (which it could via economic data) then the decline in yields will shift from a market virtue to a market vice. That’s what we need to focus on as we begin the new year. 

January is all about 4th quarter earnings reports. If even slightly positive, the markets will be up. If even slightly negative the markets will have difficulty moving forward. 

For now celebrate the 10% return since the end of the third quarter. 

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