The Goldilocks Economic Narrative Is a Fairy Tale
For months, the market ignored inflationary pressure because economic growth was considered to be just right. That is no longer the case.
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The primary market driver for the last couple of years has been a Goldilocks economic narrative. In this narrative, elevated inflation is acceptable because economic growth is strong enough to handle it but not so strong that it would cause additional inflationary pressure. The idea is that the economy isn’t too hot or too cold and can handle both rate cuts and some inflationary pressure.
This narrative received an additional boost due to optimism about Artificial Intelligence and its impact on a small group of mega-cap stocks. These stocks are relatively immune to interest rates and inflation because they carry little debt and have large cash reserves. The Magnificent Seven has helped cover mediocre action in the broader market, which has helped support the bullish sentiment.
The Goldilocks economic narrative has been destroyed in the last couple of weeks. Hotter-than-expected prices paid for services and much higher-than-expected job gains triggered concern that inflation is rebounding and that the Fed may have mishandled monetary policy by cutting interest rates too much. There is now a growing likelihood that there will be no rate cuts at all in 2025 and even the danger of rate hikes if the economy does not cool off.
Another issue hurting the market is the uncertainty about what will happen when Donald Trump takes office on Monday, January 20. One key issue is tariffs, which could add additional inflationary pressure and create some economic chaos. Trump's policies will impact the economy, and the market is nervous and uncertain about their effect.
Before Trump even takes office, there will be very important inflation news when CPI is released on Wednesday and retail sales numbers on Thursday.
To further complicate matters, the fourth-quarter earnings season is about to start. Big banks will report later this week, and then the large-cap technology results will start to hit after Trump takes office.
It is a recipe for elevated volatility, but stocks are quickly becoming oversold, and much of the market is already in bear market territory. The Russell 2000 IWM is breaking its 200-day simple moving average, and less than 40% of all stocks are over that level.
The market ignored an uptrend in interest rates for months, but now they matter. Until they stabilize, the market will have problems. The 30-year bond yield is now over 5% for the first time in a year, which will hurt real estate and many other elements of the economy.
Stocks are gapping lower early on Monday morning, but that may be what is needed to find support sooner rather than later.
At the time of publication, Rev Shark had no positions in any securities mentioned.
