Yahoo Finance The risk of an overpromising and underdelivering Fed
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We’ve all been poring over the forecasts for 2024: Where will stocks end the year? How about economic growth? Which companies will comprise the new FAANG or Magnificent Seven?
What could go wrong?
Pros spend a lot of time thinking about potential risks. At the beginning of 2023, it seemed like strategists and economists were dwelling on the downside. And most ended up being too pessimistic about the outlook for growth. In part, they anticipated the Fed’s interest rate hikes would choke off economic activity, a prediction that proved to be incorrect.
Now, the market is pricing in six interest rate cuts this year. Once again, investors could be wrong — a key risk as we kick off 2024.
That’s the view of Apollo Management chief economist Torsten Slok, for one: “Maybe the Fed swung the pendulum too much in the dovish direction,” he said of the central bank’s recent communications and the market’s interpretation of them. (Disclosure: Yahoo Finance is owned by Apollo Global Management.)
He thinks the Fed will tweak its upcoming messaging: “We’re just not there yet. 4% is not 2%. And we’re not yet declaring victory over inflation.”
That gap between what the Fed says and what the market hears isn’t new. And as it has been in the past, it could prove to be a painful — and volatile — process for the two to get on the same page.
That said, investors are cognizant of this risk. Slok isn’t alone in raising the possibility that the Fed will begin to cut rates later and by less than the market is pricing in this year. Indeed, according to Bank of America’s monthly fund manager survey, investors cite “high inflation keeps central banks hawkish” as the second-most-likely tail risk (that is, an unlikely but not out-of-the-question possibility that could derail an equity rally).
The other main risk, says Slok, is both a personal and a market-wide one — the lack of diversification.
On the market level, the dominance of just a few stocks was evident once again in Tuesday’s session, when a 3.5% tumble in Apple (still the largest stock by market cap) and a drop in the other Magnificent Seven stocks helped contribute to a slump in the Nasdaq and S&P 500.
That translates to personal portfolios as well.
“Let’s say I had the S&P 500 for the last 365 days,” Slok says. “It’s good, I had some nice returns. Now is the time to think about, ‘Do I want to be exposed to the same type of risk given what the rally was and how strong the gains were?’”
Of course, those aren’t the only risks out there. JPMorgan’s Dubravko Lakos-Bujas, one of the most bearish strategists on Wall Street, sees potential geopolitical instability, a reversal in pricing power, and softening consumer trends (a risk Slok highlighted as well) against a backdrop of rich equity valuations.
If 2024 unfolds like 2023, the stock market machine will steamroll all of these concerns. But it’s not a terrible idea to follow the pros and keep one’s eyes open.
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