Last week, the stock market’s annual ‘Santa Claus Rally’ came under attack by the bond bears. The powers behind the stock market are fighting back, but the situation looks tenuous. First, let’s look at the big picture.Considering the fact that participation in the stock market by American households is at an all-time high (as shown below), there is a lot at stake.
Fighting Back
On Friday, Nasdaq Global Indexes, the overseer of the Nasdaq 100 index on which the ETF is based, beefed up its firepower by adding the largest corporate holder of Bitcoin, Micro Strategy (), and one of the hottest AI stocks, Palantir () to the index, along with Axon Enterprises (). Micro Strategy and Palantir are up over 500% and 375% this year.You can find the , but what they won’t point out is this: By most accounts, Micro Strategy is on the list of the top 3 largest holders of Bitcoin, and the majority of its balance sheet is Bitcoin. Its mission, as stated in a recent press release is as follows:
“Our focus remains to increase value generated to our shareholders by leveraging the digital transformation of capital. Today, we are announcing a strategic goal of raising $42 billion of capital over the next 3 years, comprised of $21 billion of equity and $21 billion of fixed income securities, which we refer to as our ’21/21 Plan.’ As a Bitcoin Treasury Company, we plan to use the additional capital to buy more bitcoin…”
As you’d expect, this makes Micro Strategy a highly leveraged, often very correlated play on Bitcoin.Approximately 3,300 institutions own the QQQ ETF, and it is one of the most popular ETFs for individual investors. If you have 401k, or a pension plan, you’re likely to own the QQQ and now, by proxy, some Bitcoin.
What’s in Your Portfolio?
No need to be concerned. If Micro Strategy falls apart, it will get kicked out of the QQQ like the once high-flying AI hardware maker, Super Micro (), and the COVID success, Moderna (), which were both replaced on Friday, along with Illumna (), to make room for better performing stocks. Additionally, the QQQ has a long history of adding new members when their stock prices are “inflated,” but based on the performance of the QQQ over the long run, it works.The good news, perhaps, is that now you have an easy, very diversified way of owning some Bitcoin: buy QQQ. To be clear, this is not a recommendation.
The Santa Claus Rally
In case you’re not aware, the stock market has a tendency to rally in the last two weeks of the year. Looking at the data since 1970, December is modestly positive before its year end push higher, but in the last 10 years, it’s gotten off to a weaker start. The chart below shows this pattern with both time perspectives, along with the black dashed line indicating how 2024 is following along.
The Threat
While it may not have been obvious to most people, last week, stocks were boring compared to the fireworks in the bond market.As you can see by the chart below, is in the downside position, and the distribution of returns in the various assets has a message that investors should pay attention to.It wasn’t just a bad week for the bonds. It was the worst week in over a year. The chart below shows every move of 4% or more, highlighted in green or red to illustrate their unusual size and rarity. Bearish weeks exceeding -4% have only occurred 11 times since the peak in TLT (bottom in long rates) in the last four years.
Is Inflation to Blame?
With such a big move by the bonds in a week that released two of the three most important inflation measures, it would be easy to blame inflation.At the current point in the economic cycle, there are 3 basic explanations for rates to rise and bonds to fall: Strong economic growth, increased fear of inflation, and fear of Federal deficit funding problems.Since it was CPI and PPI week, let’s focus on the inflation idea. The theme in both reports is that inflation’s descent is slowing down and potentially turning back up. However, it’s doing so without posting any significant upside surprises.In the case of CPI in the chart below, the trend is clearly leveling out and potentially turning up in the most meaningful way since its peak in 2021-22.The same “leveling out and turning up” pattern is evident in the PPI data (see below).So, is this turn-up enough to rattle the bond market? The market has a history of surprising investors. The market moves on expectations, animal spirits, as well as hard data, but it’s often hard to know which will be the most influential over weeks or even months. This is why we pay so much attention to what the “market says” in the form of price action and then relate it to hard and soft data.An example of soft data is in this recent Bloomberg survey. As you’ll see in the chart below, economists have expressed an increased concern since September of inflation rising.As Keith pointed out in his video this week, there are certainly inflationary pressures in areas like soft commodities. The Agricultural Commodity ETF () broke out to a new 52-week last week.Strangely, the market didn’t push bonds lower immediately after either report (CPI and PPI). As you can see from the 30-minute chart of the 10-year bond futures, which trade 24 hours per day, the bonds rallied in the hour following both of the reports.As you can also see in the 10-year bonds chart, the trend was steadily lower from Monday and Tuesday leading up to and then in each of the reporting days of Wednesday and Thursday. Then, Friday continued the trend down
On Mondays, Mish and I produce a short, podcast-style video that focuses on one specific trading topic for the week. In a recent video titled, “,” we discussed why the TLT could have a substantial move due to its compression pattern at the 50- and 200-day moving average.Additionally, we suggested that you keep an eye on the high-yield bonds () as an additional warning from the bond market about the potential for weakness in stocks. HYG is not as weak as TLT, and it didn’t start falling until Thursday (after the PPI report). However, its technical condition is such that a break of the $79 level and the trend line would be an ominous sign for stocks.
What Will The Fed Think?
The most important thing on investors’ minds (the ones talking about the bond market and inflation) seems to be, “What will the Fed do considering the recent employment and inflation data?”This upcoming Wednesday, at 2 pm ET, the Fed will announce its decision on where it wants the Fed Funds rate, and it’s expected to cut that rate by 25 basis points to 4.5%. Then, Chair Powell will discuss this decision in a press conference which will likely get more attention than the news of the rate cut.The Fed Funds futures provide us with the market’s expectations for these rate cuts, and these expectations didn’t change substantially as the CPI and PPI data were announced last week.What’s most important now is how the market responds to the two charts below. The “Fed Rate-Cut Path to Slow In 2025” chart below shows that the market is currently expecting the Fed to cut the equivalent of three 25 bps cuts over the course of 2025.
From early 2023, the sentiment of investors verbally has been that the Fed’s desire to cut rates is fuel for stocks to move higher. This is to be expected.However, as you can see from the chart below, about three months ago, the market was expecting almost ten 25 bps cuts over the next 12 months. Now that number is only 3. Fortunately, during this time the stock market has shrugged off this potentially bad news and moved higher.
Where Did The Expected Rate Cuts Go?
There are several reasons expected rate cuts would be “taken off the table,” as mentioned above – the expectation of stronger economic growth, fear of higher inflation, or deficit funding problems.There are also several reasons why the stock market would go higher despite the prospect of a less accommodating Fed or even higher interest rates. One of the most powerful forces in driving the stock market higher is optimism.Last week, we provided a few charts showing the extremely optimistic consumer and investor. Below you’ll see a chart representing an extreme jump in optimism about business conditions by small businesses.
If you don’t want to rely on soft data from surveys, consider this data of the flow of funds into stocks below. Extraordinary.
If you’re looking for a market based measure of optimism, you can track the in a lot of places. You can also find our unique measure of volatility based investor optimism in Big View Premium. in investor sentiment.
Why Should Stocks Go Higher?
There are fundamental reasons to justify higher stock prices in 2025. Analysts have been raising their 2025 targets for the market as last quarter’s earnings season wound down, and new estimates looking forward were calculated. We’ll get into that in future articles.
Will We Get A Santa Claus Rally?
The Santa Claus Rally isn’t going to get saved by new 2025 estimates; they are already baked in, but they do provide a solid foundation. The next two weeks are most likely going to be driven by how the animal spirits drive the investor to feel more “risk-on” or “risk-off” in an attempt to take advantage of this year’s momentum or get positioned for next year.Unfortunately, interest rates moving up quickly (as they did last week) without a simultaneous increased belief that earnings or economic growth is the justification for higher rates is historically not bullish for stocks.Fortunately, not all stocks and sectors respond to interest rates in the same way. Here’s how the market sectors responded last week (as shown below). The month-to-date performance is in the right graph. It’s no coincidence that the best performers last week were a continuation of existing strength.
Over the last several weeks, we’ve encouraged you to look at the markets from the perspective of “since the election.” Below, you’ll find that exact perspective.
Again, it’s no coincidence that the top performers here were also the top performers in November. These pictures, combined with the asset summary at the top of this article, tell a story of which areas of the market are leading since the election, and in December, despite higher rates. Recall that higher rates were an immediate reaction to the election.If you’re looking for the Santa Claus rally, I’d look at the top of those charts. If bonds don’t stage big bullish reversals, I won’t expect sectors and indices that are in the red above to deliver a lot of holiday cheer over the next two weeks.There is, however, one person who could sprinkle some holiday cheer on the markets. Chairman Powell, on Wednesday at 2:30 ET, during his press conference. I don’t expect it, but the seasonal trend is his friend.For better or worse, the next two weeks won’t change our perspective on the prospects of a good year in 2025.Now, here is Keith Schneider with a quick look at other market factors to take note of. Every week, we review the big picture of the market’s technical condition as seen through the lens of our data charts. The bullets below provide a quick summary organized by conditions we see as being risk-on, risk-off, or neutral.
Risk-On
Neutral
Risk-Off
More By This Author:
