Markets across the globe (except China) ended 2023 positively. The bull market that started with the pandemic faced some hurdles in late 2021 and it took nearly 2 years for S&P500 & NASDAQ to reverse the losses and is currently near its All Time Highs (ATH). Indian markets on the other hand has outperformed US with Nifty scaling new ATH and ended the calendar year with a 20% return.
(Next paragraph sets the context for rest of the article, Skip the paragraph, if you wish to.)
Central Bank's monetary policy have been playing a huge role (as per design) in dictating the Market moves. Be it the Interest Rate Cuts & Quantitative Easing(QE) induced post pandemic bull market or the Rate Hikes induced breaks applied to the markets in 2022. Going by that play book, the Rate Pause was the next big event that was expected to impact the market dynamics. That was the central theme on which I had written my previous article dated April 2023. Please read the article here, if you have not. By analyzing the prior occasions when the Federal Reserve paused the rate hikes in 2000, 2007 & 2018, the article indicated that the market would react bullishly in the months following the rate pause. The rally continued until the rate cuts were announced in the past occurrences (2000, 2007), after which US Recession took center stage. And that's exactly what happened in 2023. Interest rates were paused by RBI earlier than US Fed, that marked the beginning of a rally in local equity markets. Fed held onto its rate hike cycle a bit more longer and once it paused, US markets also started rallying.
With the Fed expected to start its rate cuts sometime after March (Based on Fed Chain Powell's FOMC comments), I would expect the rally of 2023 to continue into 2024, until the Central Banks (Most importantly the Fed) categorically says they are cutting rates. Its worthy to note that bond markets lead the Fed Interest Rate Policy & bond markets have already started diving in expectation of rate cuts.
With the macro reasoning set aside, we also need to look at some technical parameters that would support such thesis. When it comes to the stock market, momentum & sentiment plays a huge role. Needless to say, both are in favor of the bulls currently. Some would argue that the market has run up a lot already, in the past year, especially with an overhang of an impending recession. And that the markets have already reached an "overbought" zone with too much optimism. Those are indeed valid points for a shorter time-frame, but the most ignored aspect of the market is that, it can remain irrational for longer periods of time. A stock or an index that keeps hitting the upper limit of momentum consistently, indicates that on a larger time-frame momentum hasn't peaked yet. Also, high momentum causes a positive feedback loop. Rising stock prices pull more money from new investors, which in-turn lead to rising price and the cycle continues. There was a recent article from Money Control that gave data on how market participant from Tier-II cities have picked up drastically in 2023. This is visible from Nifty's momentum on a daily time-frame.
The momentum has been consistently lodged at the upper band. From what I have seen in the past, such extended momentum cycles sustains the momentum with only sudden but temporary price dips, which get bought into quickly by the increased retail investors participation. And also because on a weekly time-frame momentum is till picking-up and not yet peaked, technically speaking.
When we zoom out further on the monthly time-frame, that's where the most interesting data point of momentum could be found.
The above chart plots the events when the momentum crossed the 70% mark on the monthly time-frame on Nifty. Since 1999 (Took this year to take the dot-com bubble period also into account), momentum crossed 70% mark 10 times including the latest event that occurred with December 2023. Out of the previous 9 occurrences, the market ended higher 7 times, over the following 3 month period, and 8 times, over the following 6 month period. The average returns during this period was 6.3% & 17.3% respectively. The only exception to this being the 2008 housing market bubble and subsequent market crash. Interesting, the 2008 bubble burst due to the high interest rate cycle of 2005-07.
By the law of averages, the prior success rates of 77% for the 3 month period & 88% success rate for the 6 month period makes me to believe that, the same theme could follow this time as well. This data point coincides with the thesis shared on the previous article, of how the interest rate pause induced a late cycle market rally. But this is just a probability and the market would do it's own thing, for it doesn't care. But still, we can read into data that we already have and make deductions as an educated guesswork.
Likewise, we also need to look at the other-side of a possible rally into 2024. Like how the rate pause induced the market rally, the rate hikes of 2022-23 surely must have an effect, right? After all, the US Federal Reserve hiked rates to levels that were not seen for the past 2 decades! The thing with monetary cycles & recessions caused due to high interest rates, is the "Lag Effect". It takes time for the high interest rates to penetrate into the economy to have its effect and hence the lag.
The above chart plots the S&P500, Fed Funds Rate (Interest Rate) & the Recession Periods indicated by the grey bars. The chart clearly shows a lag effect between when the peak in interest rates occurred & when the recession started. Based on prior occurrences, the lag varied from 8 to 16 months. The stock market reacts earlier than the effects seen on GDP, hence you can notice how S&P500 started going down few months before the recession began. Markets are forward looking. So its fair to say, Peak Interest Rates are followed by a Bear Market and subsequently a Recession. Perhaps, the only period when this did not happen was the 1995 mid-cycle peak in interest rates. But the crux of the matter is that, after a rally occurs into 2024 (reiterating that it may not happen also), the other side of a mountain would present itself.
Fed Interest Rates peaked and was paused in August 2023. We are 4 months into the cycle and going by prior lag effects of the rate cycle of 8-16 months, we could see a peak on stock markets in the coming months. This is where I would connect the first part of the article with the second part. When the market is caught in such high momentum, only an external event can upset the momentum. Currently, with lack of such an event, markets are free to rally until some new information hits. So, a momentum induced rally could happen over the next 1-3 quarters (3-9 months), followed by a market top and subsequent recession that could happen after the second half of next year. However, all these are highly dynamic and facts could change rapidly and we must adjust to reality as it happens. Hence a fair assumption has been put forth based on prior occurrences with the probability leaning slightly in favor of a rally in the near term.
Finally, take-away for the readers would differ based on the approach to their investments. Long term passive investors are urged to follow their investment plan religiously and take market noise such as this article, simply at face-value and even discarded if needed. If markets rally, we benefit, if it falls, we still benefit because we are in for the long haul & lower prices help in accumulation.
Traders & investors who actively manage their portfolio, can debate, scrutinize & speculate, because the unpredictability of the markets is what makes it interesting, but please do it by acknowledging that its all a probability game & needs adapting to ever changing information.
Until Next Time, Wish You a Happy New Year!