Will there be a Santa Claus Rally?
Now that the noise of the election season is over, it is time to return to fundamentals. That means the economy and Fed policy. The good news is that despite considerable uncertainty we find these key fundamentals working in investors’ favor. Economic reports have been mostly “Goldilocks,” meaning not too hot or too cold. And the Fed is continuing to cut its policy interest rate, albeit most likely at a slower pace than expected.
We are cautiously optimistic that investors will nudge aside high valuations until 2025, setting the stage for another Santa Claus rally.
Here in the US the word we keep coming back to regarding the economy is resilient. It bears repeating that the consumer has been the backbone of this condition. Positive and improving numbers continue to point to an economic soft landing, or even a no landing scenario. This is important because it is recession that is the biggest risk to stock prices. In our view, recession continues to be an unlikely scenario.
Why is the consumer so resilient and US economic growth such a tailwind? There are two main reasons: 1) Easing inflation, and 2) A relatively strong labor market. Although inflation is still above the Fed’s 2% target by most measures, there is confidence it is moving “sustainably” toward the target. Oil prices have been down significantly since the summer, food prices continue to moderate, and the Fed continues to express confidence that the pace of rent increases will slow.
US labor markets are in good shape, despite October’s meager gain of only 12,000 jobs.
This data point was written off due to strikes and the effects of the hurricanes in the Southeast. Fed officials confirmed in their November meeting minutes that, in their opinion, the labor market is generally solid.
The Federal Reserve released minutes from their November meeting recently. The central bank reiterated its view that inflation is easing toward their target and labor conditions are solid. Their outlook for monetary policy, therefore, is for additional interest rate reductions. Due to uncertainty over potential changes to fiscal policy under the incoming administration (which could be inflationary), members expressed hesitancy in predicting the “neutral” rate which neither enhances nor restricts economic growth.
All this adds up to the likelihood that the Fed will proceed cautiously, or “gradually” using the Fed’s language. Future odds for a cut this month currently are high. But expectations are for only 75 basis points in total cuts by the end of 2025.