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We begin today’s Irregular Roundup with rate cuts.

No rate cuts

John Authers

John Authers reported on investors giving up on their 2024 rate-cut bets.

While inflation is back below 3%, it remains higher than at any time in the two decades before the post-pandemic inflation spike.

Ten Year Yields (7 Circles)

There’s room for 10-year yields to track further up.

Since the fed funds futures contract for this year’s December meeting was initiated in June 2023, the 10-year yield has shadowed it very closely. That has begun to shift this year, with the 10-year yield not picking up as much as might have been predicted.

Real rates (7 Circles)

Real rates are increasing as inflation falls, and are now at their highest since 2007 – and at levels which have previously triggered recessions.

It’s the monetary easing of 2021 that looks to be the extreme outlier. The Fed’s decision to hold off rate hikes until 2022 begins to look like a historic mistake. It cannot be undone, however, and its officers will be understandably anxious to err on the side of higher rates this time around.

John also looked at what this “higher for longer” world might mean for investments.

When rates are high because the economy is strong, we can expect stocks to beat bonds. Equity outperformance has persisted ever since stocks hit bottom amid the panicked atmosphere of the first pandemic lockdown.

Stocks vs Bonds (7 Circles)

But of course, high rates (especially high real rates) will eventually slow down the economy, and then the outperformance of stocks should end.

Mag 7 outperformance (7 Circles)

One theory for the outperformance – that low rates would help “long-duration” growth stocks with lots of earnings far out into the future – has already come under pressure.

The Magnificent Seven tech giants massively outperformed the rest of the S&P 500 from the first wave of the pandemic until the Fed began to tighten in early 2022. Then they underperformed as rates rose. But since the beginning of 2023, the Magnificents have enjoyed more huge outperformance.

The explanation is the launch of ChatGPT in Nov 2022 and the resulting wave of AI optimism focused on Nvidia.

  • But this makes stocks vulnerable to AI under-delivery.

When ChatGPT launched, the Santa Clara-based chipmaker was worth more than $2 trillion less than Apple. Now, only 18 months later, ithas almost closed that gap.

Whilst the Mag7 has recovered, real estate remains crushed by high rates.

Real estate stocks pay a regular yield thanks to their rental income. The higher the yield on bonds, the less appealing real estate will be and vice versa.

Covid lockdowns and working from home didn’t help, either.

  • So if you expect early rate cuts (I don’t), then real estate might be a good bet.
Short term reversals

Joachim Klement

Joachim Klement looked at whether the short-term reversal effect is dead.