Weekly Research Briefing: Your December Pivot

December 19, 2023

After riding the Fed Funds ski lift upward since April of 2022, Jerome Powell announced last week that it is now time for the FOMC to strap on the brain bucket and 'shred the gnar'. In other words, it is time for the Fed Funds rate to go lower. This move caused immediate panic among Wall Street strategists who have barely seen the ink dry on their freshly printed 2024 market outlook. Expect many firms to send out sticker updates this week amending their GDP forecasts and risk asset prices higher. What led to the FOMC and Santa Powell being in such a joyous mood on Wednesday? From looking at the updated Fed projections, it was the collapse in their inflation outlook which caused them to look for a significantly lower Fed Funds rate going forward. Their stance was further justified by the better-than-expected CPI and PPI figures which came out mid-week. If not for housing and auto inflation, the core CPI figure would have been negative month over month for November. And remember that future housing/shelter costs are going lower given that it lags the raw data. So as inflation turns to deflation, the Fed is running the risk of tightening and hurting the economy if they don’t begin to cut rates.

“We’re aware of the risk that we would hang on too long. We’re very focused on not making that mistake.”
(Fed Chairman Powell, post-FOMC press conference)

For anyone sitting on too much cash, last week was a painful lesson. Stocks jumped another 2-3% to notch their 7th straight weekly gain. Treasury bond/note yields fell 30-40 basis points with many maturities now below 4%. The most broken, shorted and worst performing stocks outperformed (think REITs, financials and smaller cap companies). And with the risk-on move, the U.S. dollar fell 1.5% as investors added to overseas assets. For those investors overweight cash and low risk assets, they now have to decide when and how to buy riskier assets to participate in future Fed easing. Another set of investors, who have been hiding out in the Magnificent Seven mega-caps (and killing it in 2023), now need to decide if they should shift into the lower quality and smaller cap companies that will benefit from a future easing in financial conditions. There is so much for investors and advisors to think about over the holidays.

For U.S. consumers, the news is only getting better. Two and a half year lows in gasoline prices and all-time high stock prices are giving shoppers extra spring in their step this month and we are seeing the strength in retailers sales comments. The housing and real estate industry also looks to be in store for a pivot in 2024 fortunes as significantly lower mortgage rates have given buyers increased appetites. Now if they could only find a homeowner willing to sell their home and part with their 2-3% mortgage rate. It will be interesting to see how good consumer confidence is in 3-6 months as the Fed lowers rates and the Misery Index challenges its 1950's low (falling inflation and stable unemployment rates).

This week will wrap up the last of the major news and data from the markets. We will get housing, manufacturing and durable goods data. And on Friday, the Fed's most closely watched CPE number will arrive. Earnings from Carnival, FedEx, and Nike will also give us some consumer reads to look at. But other than that, investors will be looking at their portfolios to see how they want to position for this big pivot by the Fed. Barring a geopolitical event, it is easy to see that investors' appetite for risk will increase going forward. Now they just need to find the best valued assets to buy to help them toward their goal. That said, any pullbacks in riskier assets should be shallow given how much money is socked away in cash.

Have a great year end and let our team know if you need anything through year end. Thanks for all the comments, questions and advice this year. I hope that we were able to add value to your weekly readings and be of help in your thought process for your clients and your own personal portfolios. See you in 2024.

Katie Martin describing the surprisingly festive scene at Wednesday's press conference...

The only thing Jay Powell could have done to deliver a stronger impression of a festive giveaway to global markets this week would have been to conduct his press conference decked in an oversized red suit with fluffy white trimmings and a matching hat...

Powell was widely expected to give a subtle wink and a nod to markets that “you’re overdoing it, knock it off”. He did not do that at all. Instead, first he took a bit of a victory lap, observing that the recessionistas had got it all wrong. The Fed’s 5.25 percentage points of rate rises had not nuked the economy after all. Then he confirmed that inserting the word “any” into the Fed statement’s discussion of “the extent of any additional policy firming” was a deliberate acknowledgment that rate rises were likely to be over. It pays to watch the details here.

Then, perhaps most strikingly, he noted that some of the Fed’s rate-setters had trimmed their rate forecasts for the coming years in between Tuesday’s data showing that consumer prices had risen in November and Wednesday’s data showing that producer prices had held steady. Scribbling out forecasts and writing in new ones on the day of the rates decision and report is some pretty intense data dependency. The possibility of cuts was coming into view, he said, and was “also a discussion for us at our meeting today”.

Financial Times

And the Wall Street Journal's take...

Stocks surged and bond yields tumbled Wednesday after the Fed held interest rates steady and officials projected three rate cuts next year. While Powell said Wednesday it was too early to say the Fed was done raising rates, he fueled a rally when he also volunteered that officials were preparing to focus on when to lower rates.

“The question of when it will become appropriate to begin dialing back the amount of policy restraint…begins to come into view, and is clearly a topic of discussion out in the world and also a discussion for us at our meeting today,” Powell said Wednesday.

His comments sent investors in interest-rate futures markets to increase their bets on earlier and deeper rate cuts next year. Before Wednesday’s Fed meeting, they anticipated around four cuts next year beginning around May. After the meeting, they expected the Fed would make at least five cuts next year, with the first coming in March, according to data from CME Group.


The markets are now betting on six rate cuts thru the end of 2024...

The March meeting sees a 70%+ chance for the first cut in the Fed Funds rate.

CME Group

The Federal Reserve capitulated on both inflation and rates on Wednesday’s FOMC meeting, lowering expectations on both...


The FOMC switchboard should change their hold music to "Won't Get Fooled Again" by The Who...

The Fed failed to raise rates quick enough when inflation looked to accelerate higher. They don't appear to want to be behind again as inflation falls.

For months, Powell argued that we needed to see further progress on inflation, and until that progress materialized rate cuts weren’t justified. Now that inflation has dropped to about three per cent—within a point or so of the Fed’s goal—Powell and his colleagues are reacting to concerns about overdoing their anti-inflation drive and driving the economy into a recession. “Inflation collapsed in front of them, and they had to shift quickly,” Tim Duy, a longtime Fed watcher who is now the chief U.S. economist at SGH Macro Advisors, told me. “The way the Fed thinks about it is if inflation falls, holding interest rates steady means financial conditions are actually tightening, and they don’t want that.”

The New Yorker

If not for housing and autos, November's core CPI print would have been negative month over month...


Given the look through November's PPI last week, this week's core PCE inflation looks to be headed towards a 3% figure...

Cannacord Genuity

As for non-core prices, gasoline is the gift that keeps giving...

@bespokeinvest: Gas prices are now at a 2.5 year low!

Yesterday, AAA's national avg. for a gallon of gas ticked down to $3.087, its lowest level since 6/24/21.

With the S&P Total Return at new all-time highs and gas prices nearing a $2-handle, the wealth effect is chugging into Christmas.

Shelter cost is 35% of the CPI calculation. It will become a massive drag in the future...

The component's calculation lags the actual move in apartment prices due to the effect of the lease rate rollover. Housing prices also typically lag the actual event due to the time to close a transaction. So, while we know where current rates and prices might be changing hands, it takes a while to move through the full calculation.

Yardeni Research

The 30-year mortgage rate is at 6.65% today...

"NAHB estimates that every 25bps of mortgage rate decline from 7% 'prices in' >1mm households" -- BofA


...so expect homebuilders and realtors to begin to see accelerating traffic...

@LizAnnSonders: December @NAHBhome Housing Market Index at 37 vs. 37 est. & 34 prior … first gain in five months; per NAHB chief economist, “housing market appears to have passed peak mortgage rates for this cycle, and this should help to spur home buyer demand in the coming months”

Some corporate earnings comments about inflation last week...

Global label, adhesive and packaging company seeing across the board deflation...

"...we’ve moved into the deflationary period. So prices of most of the things we buy are dropping. So freight is down, oil is down. Power is down, paper is down, film resin prices are down. So we're getting some margin benefit currently that we haven't seen for a while...So how much of that we'll have to give back to the customers in the end remains to be seen. We will not keep all of it. That I can guarantee you. We will not keep all of it." - CCL Industries CEO Geoffrey Martin

And Costco Warehouse seeing goods prices coming in 100 bps lower than they expected...

"We had estimated that year-over-year inflation was in the 1% to 2% range. Our estimate for the quarter just ended, that inflation was in the 0 to 1% range. Bigger deflation in some big and bulky items like furniture sets due to lower freight costs year-over-year as well as on things like domestics, bulky, lower-priced items again, where the freight cost is significant. Some deflationary items were as much as 20% to 30% and again, mostly freight-related. TVs, the average sale prices have been lower while unit's been higher." - Costco CFO Richard Galanti

Falling menu prices at Olive Garden is a plus for customers and stockholders...

"We've seen some check softness that's being offset by lower inflation which is why we went to the lower end of our sales range while increasing our earnings outlook." - Darden Restaurants Rajesh Vennam

The Transcript

November retail sales showed that restaurants had a great month...

@jonathanmaze: Restaurant and bar sales were up 1.6% in November from October, according to new retail sales data. Interesting, given that menu prices were up just 0.4%. You may quibble with the numbers but the consumer is pretty resilient.

If traffic is rising, menu prices are positive and food costs are falling, you might want to check in with your restaurant stock analyst for their best ideas...

@LizAnnSonders: Food component of PPI #inflation fell by 4.9% year/year in November … largest annual drop since December 2015

But not all prices are falling. Cardboard prices being raised 9% starting January...

It is unusual to ask for a price increase after the holiday season. Safe to say that demand is strengthening and/or inventories have been depleted.

Cardboard prices are pointing to better times ahead.

Producers are lifting prices for the thick paper used to make delivery boxes for the first time since the Federal Reserve began raising interest rates early last year.

It is a sign that the inventory hoarding that characterized the post pandemic recovery is ending. If history is a guide, more expensive cardboard also suggests the economy is revving up.

Some analysts warn, however, that it is too soon to tell if the price increases will stick and be repeated, or if they are a one-time adjustment in a market whipsawed by the unique circumstances of the pandemic.

Big producers, including International Paper, WestRock and Packaging Corp. of America, have said that they would raise prices Jan. 1 for both types of containerboard, which are combined to make corrugated cardboard.


Wall Street getting some last M&A on the calendar as a Russell 1000 and S&P 400 company accepts an all-cash offer for $14 billion...

The final sales price is 125% higher than where the stock was trading when Cleveland-Cliffs first went public in expressing merger interest. Glasses raised to the U.S. Steel Corp board of directors and all advisors and bankers on their team. Now which profitable corporation with a name beginning in 'X' would like to have this rare single stock ticker?

TOKYO -- Japan's Nippon Steel said on Monday that it would acquire U.S. Steel for more than 2 trillion yen ($14 billion) in a move that seeks greater reach in a vital market.

The deal for the iconic American steel producer is set to be one of the largest acquisitions ever by Nippon Steel. It is aimed at strengthening the company's position in the growing U.S. market amid declining demand for steel products in Japan and the growing importance of electric vehicles.

Japan's top steelmaker seeks to acquire all of U.S. Steel at $55 per share, valuing the company around $14.1 billion, or $14.9 billion including debt. The $55 represents a roughly 40% premium to U.S. Steel's closing stock price on Friday.

Nippon Steel's crude steel production in 2022 was 44.37 million tonnes, ranking it fourth in the world, according to the World Steel Association. U.S. Steel ranks 27th, and comes after U.S. producers Nucor and Cleveland-Cliffs. With the acquisition of U.S. Steel, Nippon Steel's production would rank third worldwide.

The acquisition would give Nippon Steel a U.S. base for production of automotive steel, Executive Vice President Takahiro Mori, the Japanese company's head of global business development, said in an online briefing.

Nikkei Asia

And Russell 1000 component DocuSign doesn't want to be a public company anymore...

E-signature company DocuSign is working with advisers to explore a sale, in what could be one of the largest leveraged buyouts in recent memory.

Conversations are in the early stages, people familiar with the situation said, and there are no guarantees a deal will be reached. DocuSign could attract interest from private-equity firms and technology companies.

A deal could be sizable, given the San Francisco company’s market capitalization of over $11 billion.



Another Russell 1000 component, Alteryx, decides to go private...

[AYX] Confirms to be taken private by Clearlake Capital Group and Insight Partners for $48.25/shr in ~$4.4B deal

- Announced that it has entered into a definitive agreement to be acquired by Clearlake Capital Group, L.P. (together with certain of its affiliates, "Clearlake") and Insight Partners ("Insight"), two global private equity firms, in a transaction valued at $4.4 billion, including debt. Upon completion of the transaction, Alteryx will become a privately held company. Under the terms of the agreement, Alteryx stockholders will receive $48.25 per share in cash for each share of Alteryx Class A or Class B common stock that they own. The per share purchase price represents a 59% premium to Alteryx's unaffected closing stock price on September 5, 2023, the last full trading day prior to media reports regarding a possible sale transaction.



A global warming positioned M&A deal? Door manufacturer buys a hurricane proof door manufacturer...

And in another equity index component shrink, one Russell 2000 and S&P 600 component sells out to an equally sized Russell 2000 component.

[PGTI] To be acquired by Masonite International for $41.00/shr in ~$3.0B cash-stock deal

- Announced a definitive agreement under which Masonite will acquire PGT Innovations for a combination of cash and Masonite shares with a total transaction value of $3.0 billion. The addition of PGT Innovations provides Masonite with complementary product offerings in adjacent categories, attractive geographies, expanded routes to market and cross-selling opportunities, enhanced engineering and manufacturing capabilities, as well as a significantly stronger growth and financial profile. The acquisition is expected to deliver meaningful earnings per share (EPS) accretion and significant synergies with minimal investment required to integrate the two businesses.


Not to be left out of the equity shrinkage party, S&P 500 corporations are buying back their stock at the fastest rate in four years...

@MikeZaccardi: 4Q23 buybacks as a % of S&P 500 is tracking the highest level since 2019

The Fabulous Five now has the same market cap weighting as all of the stocks of Japan, France, China and the U.K. in the MSCI world index...

The Magnificent Seven stocks have swelled to represent about 30% of the S&P 500’s market value, according to Goldman Sachs Global Investment Research. That is approaching the highest-ever share for any seven stocks.

“It’s a mind-blowing number to me when I think about an index that’s supposed to represent such a broad group of companies,” said Ann Miletti, head of active equity at Allspring Global Investments, of the wide outperformance gap.

The influence of the big tech stocks is massive on a global scale, too. Within the MSCI All Country World Index—a benchmark that claims to cover about 85% of the global investible equity market—the combined weighting of the Magnificent Seven is larger than that of all of the stocks from Japan, France, China and the U.K.


A glance at the current trailing P/E multiple of the S&P 500 given the recent move...

@FactSet: The trailing 12-month P/E ratio for $SPX of 23.3 is above the 5-year average (22.4) and above the 10-year average (20.9).

Plenty of excitement right now around public small cap indexes. But remember that small cap P/Es are not apples to apples with the large caps...

I re-ran all the data this weekend to compare the S&P 500 (Large Cap), S&P 600 (Small Cap) and Russell 2000 (Small Cap). When the losses for unprofitable companies are added back, the 14 P/E multiple of the small cap indexes jumps to 21.7 for the S&P 600 and 68 for the Russell 2000. (The S&P 600 is more restrictive of its membership toward companies that have a history of profitability.) As you can see, both small cap indexes have a large slice of companies that are unprofitable right now which causes those companies to be excluded from the P/E calculation. Small cap stock indexes have significant price momentum in the market right now, but on a pure P/E basis they do not look like slam dunk bargains to the S&P 500. Of course, expectations for increasing M&A and more open capital market activity could make for a better environment for interest in small cap stocks.

(Source: Barchart.com data as of 12-17-2023)
 (Removed FIS in S&P 500 and LUMN in S&P 600 & Russell 2000 due to their massive one-time write downs) 

BofA Global takes a look at the small cap Russell 2000 index showing current valuations versus past markets...

Again, the P/E calculation excludes non-earning companies and is tough to compare to past markets given its high 29.5% of excluded market cap. Better to look at EV/FCF which shows the index at 14.3x at the end of November. So at least 10% higher right now. Again, not a screaming bargain.

BofA Global

If you think that the public market returns are going to cool from where they were in 2023, then you may want to look into the private equity markets...

Meanwhile, within the equity side of the traditional 60/40, we also think that control-based Private Equity investing can likely play a bigger and more important role in helping to generate higher returns in a world where our overall expected returns have fallen. Key to our thinking is that, despite a higher cost of capital, owning control positions with operational improvement opportunities can best the performance of a passive index by a good margin if our macroeconomic forecasts are correct. Indeed, history is on our side; as Exhibit 9 shows, the value of the illiquidity premium has increased when public markets have reverted towards more modest levels of return. The time to be bearish on Private Equity is not today; rather, it was actually in late 2021 and early 2022, when we believe several growth-oriented PE investors over-deployed their capital relative to trend amidst record low rates (and did not hedge in many instances).


If a private company had thoughts of ever going public, then 2024 could be their year...

The improved macro-outlook implies a more conducive environment for bringing IPOs to market during 2024. Our IPO Barometer gauges whether the macro environment is favorable to IPO issuance by combining measures relating to equity market performance, valuation, interest rates, CEO confidence, and economic activity. The barometer has rebounded to 89, near the level associated with the typical frequency of IPOs. Looking ahead, higher share prices and an improving cost of capital would imply the friendliest new issuance environment in nearly 2 years.

Goldman Sachs

Goldman Sachs

The GS Financial Conditions index has hit its lowest point of 2023 which should be good news for any company who wants to tap the capital markets in 2024...


Scary chart on the left. Not so scary chart on the right. This is the same set of data...

Easing financial conditions will allow many companies to tap the public and private markets for capital to repair broken balance sheets. But some companies will continue to go under because the business model was only sustainable in a period of zero percent interest rates. As we watch and count the numbers of companies and consumers that are having financial difficulty, or bad loans and charge-offs on bank balance sheets, the percentage increase in 2023 and 2024 might look significant. Best to also look at the numbers on an absolute basis to see what is more historically normal before making a firm investment conclusion.

Financial Times

What are the odds that Euro REITs are one of the best assets of 2024?

@RenMacLLC: European REITs with a golden cross developing in a large base formation and maybe more importantly confirmed with leadership from (hold on to your hat) European Banks?! $RMZ

If you want to dive into a stack of 2024 macro-economic and market outlooks, here is a good list of links...

Just keep in mind that many of these outlooks were created before the recent Fed pivot so might be in the process of being updated (like GS and BofA did this weekend).







Just remember, all of the above outlooks will be adjusted this month. Here are two updates from the weekend...

BofA: "Previously we had the Fed easing by 75bp in 2024 with quarterly 25bp cuts beginning in June. We now look for four-25bp cuts in March, June, September, and December, or 100bp of cuts for the year." (@SamRo)

And over at Goldman...

We raise our year-end 2024 S&P 500 index target to 5100 representing 8% upside from the current level. Decelerating inflation and Fed easing will keep real yields low and support a P/E multiple greater than 19x. Since late October, S&P 500 has surged by 15% and Russell 2000has soared by 23% as real rates plummeted from 2.5% to 1.7%. Our prior year-end 2024 forecast assumed yields of 2.3% and a P/E of 18x. Upside risk exists to our above-consensus EPS estimate of 5% growth. The improved macro outlook implies a more conducive environment for bringing IPOs to market. Resilient growth and falling rates should benefit stocks with weaker balance sheets, particularly those that are sensitive to economic growth.

Goldman Sachs

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