What We're Talking About This Week!

• Weekly Market Reset

• Key Economic Reports This Week

• Dividend Landscape

• Market Outlook

Weekly Market Reset

After a month and a half where the VIX never got to 20, the Fed delivered the big jolt at its policy meeting by taking a somewhat surprisingly hawkish stance. The markets had priced in roughly three rate cuts in 2025. The Fed’s Dot Plot report only forecasted two, but also indicated that it expects inflation won’t come back down towards its 2% target until 2026. At a high level, that’s probably a pretty good set of expectations going into the new year based on the data we have today, but when the market gets overly optimistic about what they want to see, these types of negative reactions become more commonplace.

The S&P 500 fell by around 2% for the week, but it felt a lot worse than it probably was. What was interesting to me is that no particular sector or theme stood out as a leader. Tech did the best of the bunch, but the leaderboard was really a mix of growth and defensive sectors. I think the fact that utilities and healthcare were among the leaders suggests that there’s perhaps a little more risk-off sentiment that was built. Utilities are generally considered the most defensive sector of all given its economic durability. Healthcare has a relatively lengthy history of being an outperformer in broader risk-off environments (and consider that the sector has underperformed pretty much non-stop since September). For the remainder of this year, due to seasonality if nothing else, I think tech and growth finish the year strong, but I wouldn’t sleep on the idea of a defensive resurgence come the new year.

Treasuries could ultimately turn out to be a big loser in all of this. The Fed’s hawkish cut indicates to me that they think inflation is going to be an issue in 2025. Take any Fed projection with a grain of salt, but I do think the data at this point supports that assertion. Any time inflation starts trending higher, interest rates usually follow closely. The only thing that might help avoid a bond market downturn is a big flight to safety trade. That usually involves some sort of recessionary trend or tail risk event to bring that upon the markets. Given where the economy is sitting at the moment, I don’t think that’s likely to happen soon. Investors have demonstrated multiple times over the past year that whenever something happens they fall back on the resilient economy narrative to remain bullish on stocks. The S&P 500 has barely experienced a 5% pullback over the past year and I think it’ll take a little more to really shake the market’s confidence, even after what happened this past week.

Key Economic Reports This Week

Of course, there’s not really anything major on the economic calendar this week with the Christmas holiday. The meeting minutes from the Bank of Japan will come on Thursday and that could provide some clues as to why they decided to hold instead of hike, but I don’t think we’ll learn much that’s new. Last week’s personal spending, personal income and retail sales in the U.S. all came in a little light, but not nearly enough to derail the resilient economy narrative. The next couple of weeks will be relatively quiet, which I think supports the case for a low volatility period that sees risk asset prices gently rising.

Dividend Landscape

I think the Fed’s hawkish rate cut was a positive for dividend stocks, at least relative to the broader market. I really think the Fed is concerned about inflation here. 2022 is an extreme example, but it should serve as a reminder of what’s likely to happen should inflation become a bigger problem in the new year. Value, low volatility and dividends all outperformed the S&P 500 by a wide margin as defensive plays swung strongly back into favor. It wouldn’t being the same situation, inflation going from 3% to 4% versus going from 2% to 9%, but it could have a similar effect.

In that event, I think dividend growth stocks might be better set up, but dividend stocks more broadly are probably still well-positioned. It’s tough to say whether an extended stretch of outperformance is ahead because investors have become so entrenched in U.S. large-caps and the magnificent 7. Even during the post-Fed portion of last week, stocks recovered about half of what they lost because investors dove right back in. It might require some sentiment shifts, but I do think the relative outlook for dividend stocks improved last week.

Market Outlook

It should be pretty quiet all around with little volatility. That usually is supportive of risk asset prices, so the major large-cap averages and popular themes, including the magnificent 7, should have the upper hand.

I don’t think the short-term pullback for long-term Treasuries is over. Yields have recovered slightly, but the hawkish Fed forecast and the trend towards higher inflation will not work in their favor. 5% would be my next target, but I’m skeptical it goes much above that.

For this week, however (and next), sticking with recent winners is probably a good bet.

Looking better for: S&P 500, magnificent 7, dollar, high beta

Looking worse for: Treasuries, value, small-caps, emerging markets