Know the Lag Effect: S&P 500 Investors Are Celebrating Too Soon!

Given the rip-roaring S&P 500 rally over the past several weeks, it appears that the market has already declared “mission accomplished” and loaded up on stocks for the holidays. Their holiday spirits might get crushed soon, however, as the rally is as vulnerable as it’s been all year.

The sentiment needle rapidly flipped from fear to extreme greed in November based on a misreading of Federal Reserve Chairman Jerome Powell’s statements on future interest rate policy. Powell gave no indication that rates will be cut soon, but large-cap stock investors decided to go ahead and assume imminent rate cuts anyway.

Assumptions are dangerous in the financial markets, and so is complacency. Sure, the Bureau of Labor Statistics declared that October’s Consumer Price Index (CPI) was down to 3.2%. However, Powell made it crystal clear that he wants 2% come hell or high water.

Naturally, globalists and career politicians will declare victory over inflation at every opportunity. In a recent example of this, Treasury Secretary and former Fed Chair Janet Yellen proclaimed, “We’re making considerable progress in bringing inflation down.”

Then, as if realizing for the first time that most people aren’t rich like she is, Yellen stated, “Americans still see increases in some important prices, including food, from where we were prior to the pandemic… and this remains notable to people who go to the store and shop.” So apparently, Yellen has recently made contact with middle-class Americans who “go to the store and shop.”

Not only do they shop at stores, but they also vote. That’s bad news for the current administration, as nearly 60% of registered voters disapprove of Joe Biden’s handling of the economy while only 38% approve.

Courtesy: @TaviCosta

Yet, the market isn’t the middle class and S&P 500 investors seemingly approve of the Fed’s interest rate cuts, which haven’t actually happened yet and might not happen for a while. What large-cap stock traders are ignoring is a historical pattern that doesn’t bode well for the major market indexes in 2024.

Sure, the economy might seem resilient if you cherry-pick certain inflation or unemployment figures. Nonetheless, the Federal Reserve jacked up interest rates at the fastest pace since the early 1980s. Back then, Paul Volcker’s interest rate hikes caused a recession – no “soft landing,” but just pulling the Band-Aid off quickly so America could tighten its belt and actually beat inflation.

That occurred under President Reagan, but there’s no political will to rip the Band-Aid off quickly in 2023 and impose fiscal discipline. Today’s politicians won’t allow any discomfort in the short term, especially when there’s an election year coming up in 2024.

Hence, the “soft landing” narrative will persist for a while longer, until the pain can’t be avoided any longer. It’s too late to prevent that pain, since Powell’s Fed already implemented a series of rate hikes and allowed its balance sheet of government bonds to mature/expire.

Courtesy: St. Louis Fed

In other words, the bomb’s clock is already ticking. To know the future, you need to know the past – and history indicates that the S&P 500’s eventual decline has already been set in motion.

From various sources, I’ve heard that it’s around 18 months on average, or possibly as long as 24 months, from the beginning of a rate-hiking cycle to an economic recession. Just as a reminder, the Fed started hiking interest rates around 21 months ago, and began implementing quantitative tightening 20 months ago.

So, enjoy the next three to four months if you’re an S&P 500 optimist. We’re in the eye of the storm now, the part that feels the calmest if you’re not aware of what’s going on around you.

And if history repeats itself or at least rhymes, the career politicians who peddle the “soft landing” narrative will have to answer to a very angry public. But hey, if there really is an upheaval and a full reset, maybe we’ll get to see Yellen “going to the store and shopping” like the rest of us do.