In other words, the S&P has only popped that much during periods of market stress and after large sell-offs, with policy intervention or something equivalent immediately changing the outlook. The October CPI data released Thursday morning before the open was good news, but not on par with the Fed announcing market support tools during the March 2020 pandemic sell-off.
What this tells us is that fast-money institutional investors, who’ve significantly de-risked this year, are far more worried about missing out on a year-end rally than the S&P re-touching its bear market lows. With the Fed expected to downshift to a 50bps rate hike in December, which will be preceded by November employment and inflation reports that are both likely to show further moderation, it’s hard for these investors to be short equities and bonds and long the USD—common trades for many months—going into these events. Their capitulation to the market momentum will exacerbate it, at least in the very near term. This also suggests that asset prices are likely to rise more on good news than they'll fall on disappointing news. That’s been the story for the S&P thus far in 4Q: on average, it’s 2.07% higher on up days and -1.1% lower on down days.
As a technical market driver through the year-end, the FOMO tailwind should dominate the TARA (there are real alternatives) case for reducing equity exposure as a headwind. The TARA argument is much more applicable to “long only” investors, such as asset allocators, who have investment horizons of multiple quarters to multiple years, not just multiple weeks, and usually don’t make rapid large portfolio shifts. Earning a 5% yield over the next year on a very high quality bond versus an uncertain return on volatile equities is a practical consideration for such investors. But this calculation is of little relevance to a macro hedge fund manager who’s worried about the S&P 500 rallying another 8% by the year-end.
Long-only investors also put relatively more weight on fundamentals and valuations than do fast-money investors, and as nice as it was to get a better-than-expected inflation print, the CPI data wasn’t a game-changer for the macroeconomic outlook. While there’s been gradual improvement on inflation and labor market overheating in recent months, there’s still a ways to go before the Fed can comfortably expect inflation to return close to the 2% target. It’s also been the case this year that good economic data one month has often been followed by disappointing data a month or two later. Thus, there’s reason to be cautious about making large asset allocation shifts, regardless of FOMO, TARA, or any other acronym.
Taking this all into account leads to a few thoughts on the market outlook.
First, while FOMO favors a continuation of the recent momentum into December, it’s far from a certainty. The market moves on Thursday were so extreme that at least some reversal is likely, especially since the US bond market was closed on Friday. The tailwind of very light investor positioning will also lose potency the longer the rally lasts, as it did in the summer. Plus, the rally continuing into December is now a widely held view, and fewer investors should be caught offside.
Second, the easing of financial conditions—Thursday was one of the biggest daily moves ever—could induce pushback from Fed officials who still think conditions need to be tight to bring down inflation. Chair Jay Powell’s speech at Jackson Hole on 26 August brought the summer rally to an abrupt end, and he may feel the need to do something similar now. But even if he does, it’s likely to be less damaging to investor sentiment because it would occur when the fed funds rate is 150bps higher, with another 50bps hike pending, and inflation and the labor market are more clearly moderating.
And third, the October CPI data marginally reduced the downside tail risk for economic growth and equities and the upside risk for rates and the USD, all because the Fed may not need to hike as much. This doesn’t contradict the point made last week that after the FOMC meeting outcome and recent data, the distribution for the US economy in one year now had marginally fatter tails. Instead, the market reaction on Thursday supported that conjecture and its implication of “more volatility and large market swings exacerbated by positioning as investors update their economic outcome probabilities in reaction to each new data point and Fed utterance.”
The bottom line: The path of least resistance for risk assets is to go higher over the next month, but the overall market outlook hasn’t fundamentally changed yet. Inflation is still too high and the labor market too tight for the Fed to tolerate too much easing of financial conditions. That’s a fundamental headwind that even FOMO momentum can’t overcome, and investors shouldn't be lulled into complacency. More market swings still look inevitable.
Main contributor: Jason Draho, Head of Asset Allocation
Content is a product of the Chief Investment Office (CIO).
Original report - FOMO > TARA, 14 November, 2022.