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Stocks priced for perfection could get a nasty surprise

Markets are “overly sanguine” about how easy it will be to achieve the last mile of disinflation. The Fed might not cut rates rapidly, and if they do we might not like the reasons.
Analysis

Last year’s rip-snorting Santa Rally means that stocks are now priced for perfection at a time when perfection seems very out of reach. In in its 2024 outlook for institutional clients, Fidelity Investments noted that the biggest changes in asset prices are typically driven by surprises – and there’s plenty of room for them in 2024.

“Financial markets start 2024 with a solid fundamental backdrop, including a persistent U.S. economic expansion and monetary policymakers who are inclined toward easing,” the Fidelity report says. “We believe a lot of good news is already priced into the markets, which implies asset valuations may make it more difficult for returns to surprise on the upside in 2024.”

Inflation might wind up sticking around because deglobalisation could keep the price of goods high; geopolitical and climate ructions could hit supply chains; and fiscal and monetary policy to remain accommodative alongside “record-high levels of debt”. That’s going to make it a lot harder to cut rates to the extent that investors want and expect, but markets are “overly sanguine” about how easy it will be to achieve the “last mile” of disinflation – even without adding in an unfavourable demographic setup.

  • “Factors that tend to drive more persistent inflation, including tight labour markets, have not changed materially,” the report says. “The overall unemployment rate has ticked slightly higher, although it remains near an all-time low. Looking longer term, demographic trends continue to point toward an aging work force and the addition of fewer working-age adults.”

    And if the Fed does cut rates very quickly, markets might not like the reasons. After all, they’re pricing in 150 basis points of rate cuts across 2024 as the economy hums along and inflation moderates. But rapid rate cuts are more likely to occur because of emergent risks to economic growth that could threaten a soft landing and challenge corporate profit margins.

    “Sticking a perfect cyclical landing for economic growth and inflation is never an easy task for monetary policymakers, but it’s possible the Fed will nail it in 2024,” the report says. “With markets pricing in a high probability of a perfect scenario, our guess is Fed policy decisions could supply a surprise or two along the way.”

    “As we begin 2024, investors increasingly believe inflation has been defeated without instigating a significant economic downturn. We agree that the U.S. economy has proved surprisingly resilient and will start the year on solid footing. That said, the late cycle expansion may face greater risks as the year progresses.”

    Staff Writer




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