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Investors hope (again) for interest rate cuts and a ‘Santa Claus rally’

Financial Events
By Paul Hodges on 19-Nov-2023

Central banks have created a make-believe world for the past 20 years. Stock prices always go up. And interest rates are always near zero.

So it’s no surprise that today, most investors can’t quite believe prices might go down, and rates go up.

The last month has seen another example of their confusion, as the US S&P 500 chart shows:

  • It fell 9.6% from 4540 to 4103 between 1 September – 27 October, nearly into correction territory
  • So investors “knew” that the Federal Reserve must be about to “pivot” and reduce rates
  • Without waiting for the official news, they rushed to buy, taking the Index back to 4514 last Friday

Hedge funds jumped in with both feet, as the Goldman Sachs chart shows.

In the past 10 trading days, they bought a record $70bn of US stocks. And, of course, all the Index Funds joined in. They are passive buyers and simply buy what everyone else is buying.

Naturally enough, the so-called “smart money” has rushed into the tech stocks. The main NASDAQ ETF saw a record weekly inflow last week, as the chart shows.

Clearly, everyone believed it was time for a Santa Claus rally, with Christmas coming next month.


Interest rates had led the move, as they peaked at 4.99% on 19 October. By Friday, they had fallen 12% to 4.04%.

But strangely, as the Bank of America chart shows, investors took money out of US Treasuries last week, for the first time since February.

This, of course, doesn’t make sense. If investors really believe the Fed is going to cut rates to support the market, they should be buying like crazy to capture today’s yields.

Equally puzzling was the $62M sale of Airbnb shares by co-founder Joseph Gebbia, as the chart confirms.

Founders can sell for a lot of reasons. But they don’t normally sell half their holding if they believe the shares are going higher.

This highlights the key issue. In the real world, things are really not going very well. 40% of the broader Russell 2000 companies are already losing money, as Apollo’s chart confirms.:

  • Wars are underway in Ukraine and Gaza/Israel, which could well continue for some time
  • The last of the furlough payments made during Covid have finally been spent over the summer
  • Consumers are in the middle of a cost of living crisis, as the prices of essentials have gone up
  • And the major rises in interest rates are starting to impact housing, auto and other markets

Rate rises normally take 12-18 months to work through the system. So we have to assume we are still only in the early stages of the impact. And, of course, there is no guarantee that rates have yet peaked:

What we are therefore seeing is likely ‘end of rally’ behaviour:

  • Market breadth is terrible with just 7 companies now dominating the S&P 500
  • Their share has reached 29% – an all-time record – as investors rushed to buy
  • These ‘Magnificent 7’ tech shares have risen >100% this year, but the other 493 are up just 5%.  

Yet as history reminds us, markets are only strong when most shares are moving higher.

investors are clearly hoping Fed Chairman Jay Powell will soon signal a dramatic interest rate cut. And so they are positioning for a ‘Santa Claus’ rally. But most adults know that Santa Claus doesn’t really exist.