Good News Is Bad Again
A different start to 2025... A stronger jobs market and higher inflation expectations... The market has sold off... What to watch this week... A warning from Denmark...
Today's market narrative is changing...
Last year was all about celebrating the economy's "soft landing" from 40-year-high inflation – prematurely, if you ask me (Corey McLaughlin).
Now, the story is changing...
On Friday, Uncle Sam released its December jobs report.
The "nonfarm payrolls" report showed the U.S. economy added 256,000 jobs in December, about 100,000 more than mainstream economists were expecting. Not only that, but the unemployment rate also dropped from 4.2% in November to 4.1%.
On the same day, preliminary results of a widely followed measure of inflation expectations delivered a concerning spike...
The University of Michigan's monthly survey of U.S. consumers for January showed that, across multiple demographic groups, people are expecting the pace of inflation to pick up.
So the story now is expecting high(er) inflation amid a still "resilient" economy.
People are catching on...
Year-ahead inflation expectations in the survey rose from 2.8% to 3.3%. And longer-run expectations (for the next five to 10 years) increased from 3% in December to 3.3%, marking one of the largest one-month changes in the past four years.
The folks at the Federal Reserve have said in the past that "inflation expectations being well-anchored" is one of the reasons they were confident cutting interest rates in the second half of 2024.
A weakening jobs market in the summer and the pace of inflation coming down also allowed the Fed to bring its bank-lending rate closer to what it considers "neutral."
But all that calculus has changed over the past few months, with inflation numbers picking up and the labor market remaining strong in the wake of the Fed cutting rates by 100 basis points. That's even before considering potential economic impacts of President-elect Donald Trump's second term as president.
Over the past month or so, expectations for more rate cuts in 2025, or "juice" for the economy, have dwindled. Analysts at Wall Street firms like Bank of America are now saying they don't think any more rate cuts will come this year. Chatter is even now starting about the possibility of rate hikes...
So, perhaps counterintuitively, a stronger economy (right now) means bad news for stocks (for now) because of the possibility of more inflation and tighter Fed policy ahead.
Said another way, good news is bad again...
It looks a little bit like the second half of 2021 into the bear market of 2022, when expectations for "higher for longer" interest rates kept rising.
Longer-term bond yields have been rising, reflecting more expectations for inflation and/or economic growth ahead. And the relative value of the U.S. dollar (compared to other global currencies) has also strengthened, just like a few years ago. The U.S. Dollar Index is up roughly 10% since the end of September.
That has been a headwind for U.S. stocks.
The market has sold off, broadly speaking...
The benchmark S&P 500 Index hasn't made a new high since December 6. A mainly sideways trend turned south when the Fed signaled there would be fewer rate cuts to come in 2025. The S&P 500 is now down more than 4% since its all-time high.
And if you look at the equal-weighted S&P 500 – via the Invesco S&P 500 Equal Weight Fund (RSP) – things look worse.
RSP gives each of the S&P 500 companies the same importance, compared with the market-cap weighted benchmark version, which is skewed to mega-cap leaders like Nvidia (NVDA) and Apple (AAPL)...
RSP is down nearly 8% since a high on November 29...
RSP has dipped down to its 200-day moving average ("DMA"), a technical measure of a long-term trend. That could act as a support level – if this bull market keeps going.
But a break below the 200-DMA would mean more than a garden-variety correction is afoot...
The question now is whether the 'high(er) inflation again' story is overcooked or just getting going...
We can't know for sure.
But more people in the market now believe that inflation is reaccelerating than when we first started warning about it a few months ago. Importantly, that includes the Fed itself...
As we said earlier, since the Fed's first 50-basis-point cut in September, longer-term bond yields have risen, be it for monetary policy or any other reasons.
Mortgage rates have gone up, too. That's not exactly what the Fed needs to conquer the "last mile" (housing costs) of the pandemic's high-inflation trend.
Four months ago, the Fed was saying to expect four rate cuts in 2025, totaling another 100 basis points. Last month, it signaled it may be half that. And now, it looks like the Fed might be done cutting rates altogether.
Fed Governor Michelle Bowman appears to be leading that charge... saying last week that she thinks December's rate cut should be the last of this cycle because of the "upside risks" to inflation. Those risks can come from different places...
Oil prices are one source of risk...
News of more U.S. sanctions on Russian oil producers and shippers (and the expected impacts on the major economies of China and India, which buy the oil) have triggered a sharp rise in global oil prices over the past three days.
A barrel of the international benchmark Brent crude is now around $80, its highest level in more than four months.
I don't think it's a coincidence that a rise in oil prices over the past few trading days has coincided with a fall in stocks and a continued rise in longer-term bond yields.
There are also uncertainties of what might come from the incoming Trump administration's policies. Tax cuts, border security, the "debt limit," and tariffs are all up for discussion. All can be linked to higher inflation expectations.
So there are a lot of open-ended questions about the economy as 2025 gets going... which means there's potential for market volatility in both directions.
What to watch this week...
Over the next few days, the market will digest another round of inflation numbers: December's producer price index comes out tomorrow, while the December consumer price index reading will be released on Wednesday.
If these numbers don't shock to the upside, it may be taken as good news by investors. But higher-than-expected readings could continue the down trend we've seen in stocks over the past month.
Earnings season also picks up this week, which we'll be watching closely. As we shared last week, companies that are "priced to perfection" might be in for some punishment if they don't meet lofty expectations. It's a risky time for the kings.
We're also seeing market concentration like we haven't seen in 60 years...
As of December 31, the top five stocks in the S&P 500 – Apple, Nvidia, Microsoft (MSFT), Amazon (AMZN), and Alphabet (GOOGL) – now make up 29% of the total market cap of the S&P 500 Index.
As stock market data firm Barchart highlighted over the weekend, that's the highest concentration of the top five stocks in the S&P 500 we've seen since 1964. Back then, AT&T (T), Exxon (XOM), General Motors (GM), IBM (IBM), and Texaco made up more than 27% of the index.
Investing historians may recognize these names as some members of the "Nifty Fifty." Our colleague Dan Ferris explained the Nifty Fifty in a Digest in December...
They were the Magnificent Seven of their time... the cash-gushing stocks everybody thought were the greatest businesses in recorded history, which would never stop growing.
These stocks soared during the bull market of the late 1960s into the early 1970s thanks to their reputations. But the good times didn't last. Dan continued...
Many of them lost 60% to 90% of their value in the 1973 to 1974 bear market.
We're not calling for an imminent crash. But as we've been writing recently, the concentration worries us.
Essentially, it means these companies have an outsized impact on how the overall markets move. They're a big reason why the S&P 500 has risen 22% over the past 12 months, while the equal-weighted S&P 500 has "only" gained 10%.
This dynamic might seem fine when the stocks are going up. But when they start to fall, the entire market can get dragged lower. So the S&P 500 might have some catching up to do on the downside...
Denmark is a perfect example...
Drugmaker Novo Nordisk (NVO) has ridden the weight-loss-drug trend to become the largest company in Denmark by market cap. At its current market cap of $377 billion, Novo Nordisk is nearly eight times larger than the second-largest company in the country – logistics firm DSV.
At its peak, Novo Nordisk made up more than 50% of Denmark's OMX Copenhagen 25 Index. So it's no surprise that the OMX Copenhagen 25 Index hit its recent high right around when Novo Nordisk's stock topped out during the summer.
Since September, though, Novo Nordisk's shares have fallen close to 40%. That pulled the entire index down about 14%. That has stopped the bull market in the OMX Copenhagen 25.
This could very well be what we see happen in the U.S. if the "Magnificent Seven" stocks lose enough steam. On the other hand, if the leading U.S. stocks remain strong, they could push the overall market higher despite weakness beneath the surface.
Investors aren't worried – for now...
According to economist Robert Shiller's "Crash Confidence Index," investor sentiment is very bullish. Put simply, Shiller polls investors on whether they expect a "catastrophic stock market crash" to happen within the next six months.
And right now, folks are the least concerned they've been about a possible crash since before the great financial crisis...
In the latest reading, 43% of investors didn't expect a downturn in stocks. That's well above the 15-year average of 30%. And it's the highest level for Shiller's sentiment survey since May 2006.
Back then, the reading didn't forecast an imminent crash. The S&P 500 climbed another 24% from the end of May 2006 until its peak in October 2007. But after that, the S&P 500 was nearly cut in half over the next 18 months.
Just like with the market's concentration in a few names, investor complacency isn't a reason to go out and sell all your stocks. But it does tell us something about the market environment we're in...
Now is a good time to look over your investment portfolio, assess your risk exposure, and make sure you have a plan to endure market volatility. Because if the start to this year is any indication, we could see more ahead.
New 52-week highs (as of 1/10/25): Altius Minerals (ALS.TO), Antero Resources (AR), Alpha Architect 1-3 Month Box Fund (BOXX), Constellation Energy (CEG), United States Commodity Index Fund (USCI), and Vistra (VST).
In today's mailbag, more thoughts on the prospects of Elon Musk and Vivek Ramaswamy's Department of Government Efficiency and feedback on Dan's latest Friday Digest... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.
"[Regarding] Elon and Vivek Dept. of Government Efficiency, [the] only way we will ever get out of debt is to eliminate the Federal Reserve and go back to interest free constitutional money. No more funny money. End the Fed!" – Subscriber Mark M.
"One thing I worry about is the declining value of the dollar.
"It is fine to publish the change in valuation of a stock in terms of dollars, but what if the apparent return is actually a decline in the value of the dollars? It is well known the real value [of] a dollar of currency has declined.
"I bought a new pickup in 1966 for $2,450 but now a similar pickup is about $60,000... This is a real world where the value of a 2024 dollar is about .04% the value of a 1966 dollar.
"A house which sold for $12,000 in 1966 recently sold for over $400,000... This is a real world value of a 2024 dollar of about %.03 the value of a 1966 dollar.
"The rate of devaluation has increased dramatically in recent years." – Subscriber John M.
All the best,
Corey McLaughlin and Nick Koziol
Baltimore, Maryland
January 13, 2025