Market Update; December 19, 2024

Yesterday, we experienced one of the largest stock market drops in recent memory. For the Russell 2000 Index, Bloomberg reports it was the steepest decline since 2022. This sudden, sharp drop—often referred to as an "air pocket"—occurred despite what is typically viewed as relatively benign news. The market, from my perspective, seemed primed for a selloff, and it delivered in dramatic fashion.

I often reference insights from The Sevens Report (Tom Essaye) and FS Insights (Tom Lee), as their research is objective and data driven. Here are some key takeaways from their analysis of yesterday’s market action:

Insights from The Sevens Report:

What Drove the Decline?

• The Federal Reserve’s updated forward guidance, reflecting higher inflation expectations and fewer projected rate cuts for 2025.

Three Key Reasons for the Selloff:

1. Valuations: At over 6,000, the S&P 500 is priced for perfection. Fewer rate cuts disrupt that narrative.
2. Calendar Effects: With the S&P 500 posting its second consecutive 20%+ year, some short-term traders booked profits, intensifying selling pressure.
3. The Fed: Markets were disappointed by forecasts of only two rate cuts in 2025. The Fed’s ambiguity about potentially not cutting rates at all added to the uncertainty, despite Powell’s press conference suggesting otherwise.

Medium- to Long-Term Outlook

The broader uptrend should remain intact if:

1. Economic growth remains stable (check).
2. The Fed continues cutting rates (check).
3. Inflation keeps falling (check).
4. Corporate earnings stay strong (check).

Insights from Tom Lee (FS Insights):

While yesterday’s panic was significant, history suggests it may be short-lived:

1. The VIX spiked 74%, its second-largest one-day increase ever. Such a reaction appears disproportionate.
2. Capitulation: 90% of S&P 500 stocks were negative, with the NYSE TRIN hitting its worst-ever intra-day reading.
3. Technical Support: The S&P 500 is testing its 50-day moving average, historically a strong entry point.
4. The Fed remains dovish, committed to lowering rates.

In similar instances, when the VIX spiked to comparable levels, markets fully recovered within a week 3 out of 4 times (since 2007) and within a month all 4 times. This could mirror August’s one-day drop, which was followed by a steady recovery.

My Perspective

The Federal Reserve’s communication remains inconsistent, creating unnecessary confusion. This is the same Fed that misjudged inflation as "transitory" in 2021 and has shifted its messaging multiple times since. According to FS Insights, stripping out shelter costs, insurance, and used car prices, inflation is actually below trend. This nuance is often overlooked. Overreliance on the Fed’s projections can be risky, given their track record.

As always, I welcome your comments or questions and wish you a joyful, relaxing holiday season.

Best regards,

Tim

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Timothy Davis, CFP?

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