How to Gauge the Health of the Bull Market

Clif Droke

QT Could Spell Trouble in ’24

Focus: Fixed Income

NDR Ned Davis Research
Dec. 19: With the Fed pivot party in full swing, nobody wants to spoil the fun. But investors should be aware of some coming risks.

One of the biggest macro risks for 2024 is the continued reduction of the Fed’s balance sheet, or quantitative tightening (QT). [Fed Chairman Jerome] Powell has pledged that QT will continue unless the economy collapses.

The Fed’s balance sheet has shrunk by $1.25 trillion from its peak in April 2022, shortly after the Fed started raising rates (using total reserve bank credit to represent the balance sheet). All the decline has come from the reduction of the usage of the Fed’s Reverse Repo Facility (RRP), which has declined over $1.5 trillion over that same time.

Bank reserves are little changed. In fact, reserves have risen to their highest level since April 2022, thereby supporting the risk-on rally. Effectively, the shrinking of the Fed’s balance sheet has had no effect on banking liquidity! No wonder why we are having a tough time seeing the impact of the Fed’s tightening cycle on the real economy.

That will change in 2024. If the Fed keeps going with QT and the Treasury keeps issuing a ton of Treasury bills (both pretty good bets), the RRP will go to zero, probably sometime in Q2. At that point, QT will begin affecting bank reserves, draining the market of liquidity. That won’t be a happy time for the markets. In the meantime, enjoy the party.

Joseph F. Kalish

Stocks Aren’t Overpriced

Market Strategy Radar Screen: Monthly Chart Book

Oppenheimer Asset Management
Dec. 17: Bloomberg’s forward price/earnings ratio for the S&P 500 stood at 21.9 times at the close on Dec. 14, 2023—down from a recent peak of 27.23 times on Sept. 2, 2020. The 20% decline in the forward P/E multiple from its peak levels in late 2020 stems from a rise in forward earnings estimates and the market’s serial pullbacks. This leaves current valuations at what appear to be relatively attractive levels.

John Stoltzfus, Jim Johnson

Forecasting 2024

The Pulse of the Market

RBC Capital Markets
Dec. 19: The strength of the S&P 500 in 2023 has surprised many strategists, ourselves included. Though we were more constructive than many of our peers, we weren’t nearly constructive enough. We started the year with a year-end S&P 500 target of 4,100, which we raised to 4,250 in May. Throughout the year we’ve used roughly half a dozen models, and have based our target on the median or average of them. In hindsight, there was one model that we should have paid more attention to. That was our valuation model, which uses the relationship between trailing average P/Es and inflation, GDP, and interest rates dating back to the 1960s to project where the trailing P/E of the S&P 500 should be at year end.

What this model is telling us about 2024 has been a big topic of conversation in investor meetings. Currently, it’s calling for a trailing P/E at year-end 2024 of 23 times, or around 5,300 when used in tandem with our 2024 EPS forecast of $232. The 2024 output of this model will likely evolve in the coming months as consensus forecasts for inflation, GDP, and interest rates are adjusted and as we fine tune our own 2024 EPS forecast. But for now, the key things to know are that it is telling us that the stock market is likely to end 2023 at a valuation level that is reasonable in the context of the moderation in inflation that we’ve seen, and that we should look for additional gains in 2024 as inflation continues to ease and interest rates come down a bit.

Lori Calvasino

Unlocking Home Sales

Economic Preview

Regions Financial Corporation
Dec. 22: After last week’s deluge of data, things will be much quieter in the coming holiday-shortened week. In case you spent last week scouring stores for superhero economist action figures to give as gifts and therefore weren’t keeping track of various data releases, here are some highlights:

Starts of new single-family homes rose sharply in November, which went way beyond the data being flattered by seasonal adjustment. On a not seasonally adjusted basis, single-family starts rose in November, meaning this year joins 2013 as the only years since 1970 in which unadjusted single-family housing starts rose in November. While many attributed this to mortgage rates having retreated from highs in October, that explanation is hard to square with the 12.8% decline in not seasonally adjusted single-family housing permits in November.

In our preview of the November data, we noted that builders paring down sizable backlogs of units permitted but not yet started would lead to starts outperforming permits, and the data reflect that. The question going forward is what kind of response the recent sharp declines in mortgage rates will bring from builders, buyers, and sellers of existing homes. While lower mortgage rates may begin to unlock inventories of existing homes, we think it will take a much more pronounced decline than we’ve seen thus far to trigger a meaningful supply-side response in the market for existing homes. To that point, while sales came in as our forecast anticipated, inventories of existing homes for sale fell in November, with the level of inventory equivalent to 3.5 months of sales, a sign of how chronically imbalanced the market remains.

Richard Moody

To be considered for this section, material, with the author’s name and address, should be sent to MarketWatch@barrons.com.