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The Most Important Short-Term Market Indicator

April 09, 2024

Markets became substantially more volatile last week compared to the past few months as investors were hit with potentially negative headlines from numerous directions including earnings (bad retailer results), economic data (too hot), geopolitics (Iran/Israel conflict) and inflation (high oil) and interpreting what these headlines meant for markets kept us busy all week.

But in that analysis, I identified one indicator that, while not perfect, did do a good job of assimilating all these various headlines and telling us what they mean for markets in the short term, and that indicator was the June rate cut probability.

With economic growth solid, the biggest fear for investors in the short term is that the Fed will delay interest rate cuts, bond yields will rise and that, over time, will increase the chances of a hard economic landing or recession. That’s why all these different headlines impacted stocks last week— they were all viewed through the lens of “what will it make the Fed do?” And that’s going to be the driver of markets for the near future, until either 1) Growth rolls over or 2) We get a definitive answer on whether the Fed cuts.

The reason I’m alerting you to this is simple: As a broad rule, for the next several weeks, as June rate cut probabilities go, so should the market—and we’ve seen that in practice over the past few weeks. On March 20, the Fed essentially telegraphed that they planned to cut rates in June and June rate cut probabilities rose around 90%. That expectation fueled a rally in the S&P 500 to new all-time highs. However, in the past two weeks, rate cut probabilities have declined and become more volatile as 1) Economic data has been borderline “Too Hot,” 2) Inflation metrics (including the Core PCE Price Index) essentially flat line and aren’t declining and 3) Fed speak has turned less dovish (at least for many Fed speakers not named Powell).

Not surprisingly, the decline in rate cut probabilities has coincided with an uptick in stock market volatility and a mild pullback in stocks. Here’s why this matters. We’re going to continue to be inundated with headlines over the coming weeks on inflation, economic data, geopolitics, oil, etc. The financial media will, as usual, try to make each of these headlines seem important. The easiest way you can tell if a headline or event really matters to markets is to look at the June rate cut probability. If it doesn’t move, then that headline or event doesn’t matter in the short term.

Watching that indicator will help you cut through the near-term noise in this market, and we’ll be watching it for you and communicating any substantial moves to you (along with what it means for markets). Understand we don’t invest just for the short term. But what happens in that time frame still matters, especially when the market is stretched on valuation and sentiment is complacent, and I don’t want you blindsided by sudden volatility or an air pocket that gives back 5%-10%.

Bottom line, whether the Fed cuts in June is important, not so much because of the date but instead because it signals 1) When the rate cut cycle begins and 2) Will give insight into how many cuts we can expect in 2024 (if they cut in June, it’s probably three cuts in 2024 and if they don’t cut in June, it’s likely two cuts or less in 2024). Whether that occurs will be the driving force for markets over the coming weeks and largely determine whether we get a further pullback (or not).

Understand that I am talking about a near-term issue. Markets still depend on earnings news to sustain rallies. Over the next several weeks, we get the results for the first quarter, and the markets will move up or down on every number. I will provide you with the valuations and the positive surprises. I believe the long-term results of the markets will be dependent on the continuing results of corporation’s profits and earnings. Stay tuned because next week we begin the earnings season.

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