This morning I read the transcript of an interesting interview with a senior JP Morgan bond official. The basic issue was how the bank ended up being so wrong last year about the direction of money policy, and therefore the course of both the fixed income and stock markets.

The answer I read–although not necessarily what JPM said–is that the Fed typically (always?) keeps money policy too restrictive (basically, interest rates too high) for too long as it drains the economy of extra stimulus applied earlier to soften the blow from a potential major calamity, in this case, the pandemic. The Fed was on course to do so again this time around when cracks began to appear in the capital structure of medium-sized banks in 2023.

The poster child for this phenomenon was Silicon Valley Bank, whose head sat on the board of the San Francisco Fed, but which had made the T-Ball-level blunder of investing tons of depositor money in long-dated Treasuries when interest rates were close to zero, without maintaining hedges against the inevitable losses that would be caused by a return to normal, i.e., by higher rates. That made the bank itself a huge bet on short-term rates remaining near zero. (I have no idea how this could happen; my guess is that the bank was at first properly hedged but later sold the hedges to make quarterly earnings look better. That would be sort of like the Titanic deliberately crashing into the iceberg because they’d run out of ice cubes for passengers’ drinks. Still, something that dumb had to have happened).

Anyway, the fact that the fissures occurred in the banking system made them immediately visible and fixable in a very focused way. Had they happened elsewhere, the Fed would have kept on tightening, as usual, until recession was inevitable. So in a sense SVB may have saved the wider economy from a downturn. 

As for 2024, JPM thinks that, the Fed having achieved a “soft landing,” short rates will fall considerably this year and the 10-year Treasury will decline from the current 4%-ish to ~3.5%-3.75%.

Sounds plausible to me.

Three implications for the stock market if this is right:

–earnings will be better than the consensus thought late last year

–in the simple way I look at things, a 4% yield on the 10-year is sort of like a 25x multiple on stock market earnings; a 3.5% yield is like a 28.5x multiple. So the JPM view on rates suggests that mild multiple expansion for the US stock market this year is possible, in addition to whatever gains unanticipated earnings strength may bring

–there’s also a chance that declining short rates will cause a chunk of the large amount of money now in CDs or money market funds to end up in stocks (or to be spent in ways that create further positive earnings surprises).

None of this is game-changing, as they say. But together they suggest at a minimum that there’s more downside protection for stocks than I think the consensus .

what actually happened in 2023:

–the US was the best place to be, with the domestic stock market making a total return of about +26%. Tech was the best place to be in the US, gaining more than +50%, with Energy and Utilities the worst–and in the minus column. The Dow was the weakest big index (no surprise), barely making it into double digits

—India was also a great market to be in, gaining 18% or so, but emerging markets overall, measured by the MSCI emerging markets ETF (EEM), barely broke even in $US

—Japan looked good, too, with results (TOPIX index–slightly higher using the Nikkei Dow) in local currency at +25%. But an 8% decline in the yen vs. the dollar reduces that to a 15% rise in US currency terms

—China, an almost universal pundits’ favorite (what were they thinking?) despite the continuing crackdown on entrepreneurial (meaning making actual profits) companies by Beijing, the massive housing/construction/banking crisis and the destruction of Hong Kong as trusted intermediary between China and the rest of the world, ended near the bottom of the pile. Shanghai was (after a currency gain) +3% in $US, Hong Kong -15%.

what the brokerage strategists are saying (as I read them):

–great year, with gains of about +20% on world stocks!!!!!

–Japan was on fire, with gains in yen of +25%!!!!

–lndia also shows how underweighting the US and overweighting Asian markets was a good idea. (No discussion, though, of any added compensation (over the return on the S&P) one should get for the risk of investing in a place with no strong securities regulator and with iffy, at best, financial disclosure.)

I’m of two minds about the market-speak. On the one hand, I think customers deserve an honest accounting. On the other, making an accurate assessment of one’s weaknesses is, to me, the first step toward improving results. Self-delusional marketing just makes it easier for you and me to continue to beat the pros. Also shows the value of index funds/ETFs in areas like India that I don’t know much about.

The January effect is the idea that stocks generally go up in the first month of the new calendar–and portfolio manager performance measurement–year.

The generally accepted explanation for this is that taxable investors sell both their clunkers and some of their winners in December to realize taxable losses and offsetting losses. Mutual fund investors do this sort of housekeeping in October, but their separate account colleagues and other large taxable accounts also join the December portfolio tidying up.

With the negative effect on prices of all this year-end selling, the argument goes, there’s a natural bounceback of the market in January.

That’s the story anyway. But the reality is that most of the unusual gains that have historically come in January can be explained by the bounceback of speculative small-caps that are depressed in December by a combination of retail selling and market makers shifting prices dramatically lower so they won’t have to take on too much inventory.

The interesting thing about this January so far is that stocks are going down, not up. To me, this looks like individual taxable investors taking profits on stocks that have had strong Decembers. So rather than realizing losses for 2023 taxes they’re taking gains they won’t have to pay taxes on for another year.

If I’m correct, this would imply some combination of increasing retail involvement in the stock market and the waning influence of mutual funds as lower-cost ETFs (which don’t typically need to do traditional fund tax planning) take market share away from them.

I’ve just updated my Keeping Score (ii) page for December and full-year 2023. The past year reversed losses from 2022 in most sectors, but not much more than that.

Happy New Year!!