Hallmark Xmas

Damn the Torpedoes, Full Speed Ahead: There seems to be a growing sense in the market that nothing will curtail the boundless optimism over endless economic growth pushing stocks higher; inflation will behave, and all will be right in the world. Everyone is on the same side of the trade, and risks are insignificant annoyances. This dynamic increases volatility in both directions. Equity markets will likely race up as sellers can be sidelined, but any small hiccup in such a one-sided consensus can cause an abrupt reversal, which will be difficult to sidestep. We believe the best way to navigate this is to lengthen one’s time horizon and not get overly involved in short term fluctuations. 

Keep Dancing: Musk Will be a Trillionaire by Next Quarter

The world’s richest man just saw his net worth increase by more than 75% in less than nine weeks. Billionaires have seen their wealth double over the last decade, but the jump in Musk’s fortune is one for the ages.

This is simply a stunning fact that deserves some reflection. It is a hallmark of our times.

In 1986, Japan, only four percent of the land mass of America, had a real estate value four times that of the combined 50 states. In 1985, this disparity was also crazy, but the irrational behavior still lasted another year. Therefore, who is to say Musk cannot continue his run? Elon is now worth three times Warren Buffett, creating a wealth disparity even among the super wealthy. Meanwhile, FARTCOIN (Solana’s AI-related meme coin) has put Musk's meteoric ascent to shame, appreciating faster than Musk’s nine week jump in just days; that puts the move into Tulip Bubble territory. We are becoming a bit uncomfortable with these developments.

Bringing in another allegory, we are reminded of Citibank CEO Chuck Prince, branded by his July 2007 view that liquidity smooths out any economic disturbances: “…as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” We could see a replay of 17 years ago, where markets stumble similar to August 2007 followed by one last October 2007 high. We have seen this movie before, and it’s not a Hallmark Christmas sequel. Our only solace is that, for now, the credits have not started rolling.

Banks Unleashed?

There is a potential ace up Trump’s deregulatory sleeve. There have been discussions with incoming Treasury Secretary Bessent and the newly formed Department of Government Efficiency about merging the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and parts of the Federal Reserve. Normally, we would dismiss such a dramatic possibility, but a major restructuring/elimination of financial oversight is consistent with the new administration’s goals of:

1. Shrinking government,

2. Decreasing regulation, and

3. Juicing the economy.

Since it would check all the boxes, the effort to make the change may gain sufficient momentum to become a reality.

This elimination of bank oversight to such a degree would represent a regime change in bank regulations, creating an extremely beneficial climate for banks. The hope is that it will increase lending that would support economic growth. Banks rallied strongly after the election results, boosted by such deregulation hopes. Unfortunately, on a relative basis to the S&P 500, banks have sagged lately back to the level that existed before Trump’s win.

The question we ask is whether improved access to loans will be matched by increased loan demand. If the market is convinced loan demand will power the economy, banks will outperform and drive market indices higher. Bank insiders will see the loan demand first and will begin buying their shares—an absence of buying will be problematic.

The Fed’s New Look for 2025: Inflation? Fuhgeddaboutit.

First, forget about the Fed’s rate decision on Wednesday. It is locked in on a 25-basis point cut. With the drop in Primary Rents and Owners’ Equivalent Rent in November’s Consumer Price Index inflation report, members of the Federal Open Market Committee (FOMC) are now even more convinced that rent inflation is slowing. This fits nicely with the central bank’s increased confidence in a soft landing. From their perspective, they are destined for success: inflation is under control, allowing them to ease the fed funds rate toward neutral to help support a softening employment trend.

Second, the key question is by how much and how fast do they ease?

That question will be answered by the FOMC’s forecast found in their December Summary of Economic Projections (SEP). Released with the rate decision of a 25-basis point cut, we will look for changes from September’s 2025 FOMC forecast that expected another 100 basis points in rate cuts, with Core PCE inflation tapering to 2.2%. Given the uncertainty surrounding tariffs and immigration/deportations, they will ignore those potential negatives and lean toward a better economic forecast based on an improved productivity outlook. That should secure their favorable view from September and leave their forecast unchanged for 2.2% core inflation at the end of 2025.

Third, the problem is whether the Fed changes their Longer Run fed funds forecast (beyond 2027), currently at 2.9%. This represents the level at which they will stop cutting, a prospect the stock market does not want to consider. One year ago, their neutral rate forecast was 2.5%, so if there are further increases on Wednesday to 3%, it would reflect a less restrictive monetary policy. In September, 7 of the 19 FOMC participants anticipated a neutral Fed rate above 3%. If that number moves to 10 or more in December’s SEP, then a majority is leaning toward a high terminal rate, which would concern investors that there may not be more rate cuts in the pipeline  to support sagging employment.

What to Look for This Week

1. Central Bank I: Market Consensus is as close to 100% as can be for a rate hike of 25 basis points at 2:00 p.m. E.S.T. on December 18 by the FOMC. More important, will be the Summary of Economic Projections forecast for the funds rate for 2025 and the terminal rate. Powell’s press conference scheduled for 2:30 p.m. E.S.T. should not contain many surprises.

2. Central Bank II: The Bank of Japan (BOJ) will tell us whether it has kept its key short-term interest rate at 25 bp at 9:30 p.m. on Wednesday night, December 18. The overnight call rate (OCR) was raised for the first time in 17 years to 0.1% in March and to 0.25% in July. Governor Ueda and the rest of the Monetary Policy Board members have been hesitant to raise rates again due to trade policy and global economic concerns. If they do raise again this week, it shows they have confidence that stronger wages will help consumption and are not concerned about the negative impact of tariffs. Consensus is for a rate hike in January, but if they hike following the Fed’s rate cut this week, it would be the most significant event of the month. The press conference at 1:30 a.m. E.S.T. Thursday December 19 could shed light on a January hike if rates stay unchanged at this meeting.

3. Also Rans: Friday, December 20 at 8:30 a.m. E.S.T. November Personal Consumption Expenditure Price Index. It means little coming after the Fed meeting but could influence short term price action and sentiment. Initial Jobless Claims released 24 hours earlier on Thursday could be an excuse for profit taking if it continues to rise for the third straight week. A move above 250,000 will generate jitters but use the 4-week moving average of the data since it is a noisy series.