Much like a surprise holiday guest, December’s market shift was uninvited and unplanned. After the US election, equity markets were in full party mode, with investors dreaming of a booming economy, Chinese stimulus, and the possibility of future rate cuts. It was a powerful mix of positive factors that pulled money off the sidelines and into risk assets. For six weeks, the gains kept rolling in. But by mid-month, momentum took a sharp turn, and what seemed like smooth sailing into the New Year quickly became much choppier.
In a way, the market needed this. After seeing returns soar over 20% YTD, investors had become a little too comfortable, sitting on positions and taking some time off. This complacency allowed some froth to build up in the market. By mid-December, stocks like Tesla had surged over 100% since the election, Broadcom added $300 billion to its market cap in just two days around earnings, and names like AppLovin (…seriously, how is that a real company’s name?) soared 400% in a few weeks.
It had all gotten a little too easy; volatility was inevitable. And sure enough, it came.
Behind the scenes, the conditions for a selloff had been building for days, with some unusual price action. The DJIA had dropped nine days in a row, value indices were enduring their worst 10-day stretch in years, and transport stocks (a leading indicator) were collapsing. But the S&P 500 and Nasdaq were still near record highs, as the performance of mega-cap tech stocks masked the broader weakness. It was one of the narrowest markets we've seen in a long time.
The final spark came from the FOMC meeting. As expected, the Fed cut rates by 25 basis points, but it was what followed that shook things up. Chair Powell admitted that the decision to cut rates at all was a close call. Markets had been anticipating three or four cuts next year, but the next morning, the consensus was down to just one.
While there are cracks in the U.S. economy, it’s performing better than expected, and this is before Trump steps in, where the expectation is he’ll supercharge growth. Combine that with the risk that inflation may take longer to tame due to tariffs, and it's hard to make a case for aggressive rate cuts.
The first reaction during the FOMC meeting was seen in the FX markets. The US dollar surged against every other currency. The Canadian dollar fell below 70 cents for the first time in two decades, the Euro and Yen both dropped, and emerging market currencies got crushed.
Bond yields also responded violently to this decision. The US 10-year bond yield, which had fallen to 3.6% in September, moved to over 4.6%. Optimism of much lower yields for next year evaporated quickly. Powell’s comments about being close to a neutral rate took the headlines.
In equity markets, this spike in yields was the tipping point. The day of the FOMC meeting, the Nasdaq tumbled over 3.5%, the S&P 500 dropped 3%, and the small-cap index (IWM) plunged 4.5%. When the dust settled, the DJIA had given back all its gains post the election, by the end of the month many other markets had done the same. Commodities also took a hit, with most of the gains from earlier in the fall wiped out by the strength of the dollar.
So, where do we go from here? It seems the FOMC welcomed the selloff as it helps flush out excess from the market, putting us in a better position ahead of what promises to be a volatile time in Washington. The US economy is stronger than expected, and we may need to get used to a world where higher growth means higher yields for longer than many had anticipated. As long as yields don’t spike too high and inflation doesn’t spiral out of control, the economy’s strength should support earnings growth.
After two years of solid returns, it’s tough to imagine a third year at these valuation levels. We may be entering a new normal with more moderate returns and higher volatility. Tactical strategies and hedging will be key to navigating this period. Hopefully, everyone was able to recharge over the holidays—because the next stretch in the markets could be anything but relaxing.
— Greg Taylor, CFA, is the Chief Investment Officer of Purpose Investments
All data sourced from Bloomberg unless otherwise noted.
By the numbers displays the total returns for the month of October 2024.
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