Fed Talk

By Matthew Gutierrez and Shawn O'Malley · December 11, 2023

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U.S. stocks continue to dominant by virtually every metric. It’s not just in 2023, with the S&P 500 up ~20%.

U.S. stocks have been outperforming international stocks for over 15 consecutive years, and it’s not even close.

?Is a reversion to the mean in store, or will U.S. stocks keep outpeforming in the decade ahead?

— Matthew & Shawn

Here’s today’s rundown:

POP QUIZ

?What percentage of all dollars invested in U.S. startups this year have gone to AI companies? (The answer is at the bottom of this newsletter!)

U.S. stocks continue to dominant by virtually every metric. It’s not just in 2023, with the S&P 500 up ~20%.

U.S. stocks have been outperforming international stocks for over 15 consecutive years, and it’s not even close.

?Is a reversion to the mean in store, or will U.S. stocks keep outpeforming in the decade ahead?

— Matthew & Shawn

Here’s today’s rundown:

POP QUIZ

?What percentage of all dollars invested in U.S. startups this year have gone to AI companies? (The answer is at the bottom of this newsletter!)

Today, we'll discuss the three biggest stories in markets:

• Investors take on more risk entering 2024
• It’s not “will” the Fed cut rates, but why?
• Shohei Ohtani redefines the big sports contract

All this, and more, in just 5 minutes to read.

CHART OF THE DAY

IN THE NEWS

Investors Want More Risk Ahead of Interest-Rate Cuts

Risk on? Risk on.?

A year ago, the stock market had just tumbled. Tech was in the gutter, and Wall Street analysts were staying cautious. With cash earning about 5%, why look elsewhere?

The roaring 20s? Well, virtually everything rose in 2023, and now investors are taking on more risk ahead of possible interest-rate cuts.?

• Look, there’s no guarantee the Fed is done raising rates or will cut them (more below), but history suggests they’ll cut eventually, and when they do, stocks tend to do quite well.
• Stocks and bonds perform better in a pause before rate cuts than after, per The Wall Street Journal, whose chart below illustrates this trend.
• Since 1990, stocks bought in the six months after the first rate cut have returned an annualized average of 15% vs. 21% for investments made during the pause.
• As for bonds? 15% return in the pause, just 7% afterward.
• “This period in between the last Fed hike and the first Fed cut tends to be a really rewarding time,” said one investment strategist at BlackRock.

Leaving cash: Some financial advisors say people turned too cautious last winter, just when they should have been more aggressive. But, the pending rate pause (TBD) could coincide with rising stock prices, giving them another chance to make money in the market.?

• Investors have noticed, dropping $3 billion out of money-market funds since early November. Much of that is going to equities.?

Why it matters:

Cash rarely hurts. The late Charlie Munger advocated for having plenty on hand — a “boatload of cash,” he might say — not just for emergency expenses but also because you can use cash to pounce on outstanding investments that might arise unexpectedly.?

Still, many advisors advise staying invested because it’s difficult to time the market, if not impossible, and holding stocks over long periods has outperformed virtually every other strategy.?

• Said one strategist: “It’s too risky to be out (of the market) in the long term.”

Read more

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?? It’s Not “Will” the Fed Cut Rates but “Why”

In today’s edition of We Study the Fed…kidding, but you’re not wrong if it seems like we talk about the Fed a lot. Of course, the Fed just responds to economic realities.

And while most in markets agree the Fed will cut rates next year in response to changes in the economy, what matters more is why they’re cutting rates. In other words, what’re they responding to that spurs the expected cuts?

Embrace debate: Bloomberg calls this “the most important question facing markets next year,” for good reason.

• On the one hand, if the Fed feels it can bring down interest rates as inflation normalizes without destroying the economy (aka a “soft landing”), then 2024 should be a promising year for investors.
• But if the Fed cuts rates to stimulate the economy out of a recession, the boon of lower rates could be entirely offset by a slump in corporate profits for stock investors.

Either way, though, the timing of cuts remains a contentious topic. According to Bloomberg, in the last five Fed rate-hiking campaigns, the first pivot toward cutting rates usually came eight months after the last hike.

• Since the Fed last raised rates in July, many have pegged March 2024 for the rate cut — eight months later.

Why it matters:

Looking ahead, markets have “priced in” 110 basis points of cuts next year.

Translation: Investors’ consensus is that the Fed’s policy rate, which serves as the baseline across the financial system, will move 1.1% lower in 2024, down from 5.25%-5.5% currently to roughly 4%-4.25%.

• This would likely bring down mortgage rates, credit card rates, financing costs for companies, and even help the federal government by reducing the interest on Treasury bonds used to fund budget shortfalls.

But what happens to mortgages, credit cards, corporate financing, the stock market, and so on depends on the big question mentioned above: Are rates falling due to lower inflation, or are they falling because of a recession?

• If rates fall because the Fed is fighting a recession, the positive benefits of lower rates generally would be offset by the negative effects of an economic slowdown.

Also of note: A recession would likely spur a sharper decline in interest rates as Fed officials jump into action, particularly after their recent blemish in responding too late to inflation, whereas a soft landing-induced cut to rates would happen more gradually.

• Expect 2024 to be filled with debate, in real-time, over which is unfolding.

Read more

MORE HEADLINES

??How the poinsettia became a $213 million industry in the U.S.

?? Macy’s investors mount a $5.8 billion buyout

?? What Sam Altman did to get fired as OpenAI’s CEO

???? Why the U.S. economy has powered ahead of other rich nations

?? The number of workers on strike fell by a third in November

?? Fixed income ETFs to watch in 2024

? Shohei Ohtani Redefines the Big Sports Contract

We know professional athletes make big bucks, but Shohei Ohtani has taken it to a whole new level.?

One of Major League Baseball’s top stars, Ohtani, 29, just inked a monster 10-year, $700 million deal with the Los Angeles Dodgers. It’s the biggest sports contract in North American sports history by a wide margin.?

• Ohtani’s deal is 64% more than baseball’s previous record, a $426.5 million deal for Mike Trout.
• Ohtani commanded the most lucrative deal in North American sports history mainly because he’s hailed as the closest thing the game has seen to Babe Ruth. He can pitch and hit at the highest level. And he’s already a two-time MVP.

Who pays for this? Well, mostly fans. Ticket sales, merchandise, and corporate sponsors drive enormous revenue for pro sports, especially in major markets like New York and Los Angeles. Big TV/media rights deals, too.

• Ohtani will make a lot of money over the next decade, but so will the state of California. After taxes and agent commissions, Ohtani will take home about $33.5 million of the $70 million annual salary.

That doesn’t include his endorsements with New Balance and dozens of Japanese brands, many of which pay for signage in MLB ballparks. All told, Ohtani makes over $20 million per year just on off-field endorsements alone, bringing his annual total to nearly $100 million.

Why it matters:

The value of pro sports contracts has grown dramatically over the past couple of decades.?

• Ohtani’s deal came the same week golf star Jon Rahm, also 29, signed a three-year, $300 million deal with Saudi-backed LIV Golf.
• Rahm and Ohtani will earn more than the $60 million Argentine soccer star Lionel Messi is making to play with Major League Soccer’s Inter Miami.
• For context, the average NBA player makes about $10 million; the average NFL salary is about $3 million; and the average MLB salary is about $5 million.

Some analysts argue that Ohtani might be underpaid given how much interest he drives for the sport, how many seats he seals, and how rare a talent he’s become. On the other hand, any sports figure is only a major injury or two away from calling it quits, so it’s risky for teams to sign players to such long-term contracts.?

The bottom line: Spots is a massive, (mostly) profitable industry because of the enormous fan bases that love their teams. And since only a select few can perform a sport at the highest level, they earn what the market dictates: a lot of dough.?

Read more

QUICK POLL

Do you think the Dodgers overpaid for Shohei Ohtani?

Yes

No

Friday, we asked:?Will 2024 be a better or worse year for growth stocks vs value stocks?

— One reader commented, “Growth stocks have been outperforming value stocks since 2009, and I don't see why anything would change in the near future.”

— Another wisely added, “It depends on how you classify value and growth stocks. There are a lot of stocks in value indexes that I wouldn’t say necessarily belong.”

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TRIVIA ANSWER

?Crunchbase finds that roughly 25% of all dollars invested in startups in 2023 have gone toward AI companies.

SEE YOU NEXT TIME!

That's it for today on We Study Markets!

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