The U.S. market is at a critical juncture with a contentious election, a Fed meeting, and numerous earnings reports on the horizon. A significant liquidity rally is underway, raising hopes for a year-end rally, yet concerns about a potential corrective move linger, especially after an 11-month rise. Despite strong bullish sentiment, skepticism remains due to insufficient changes in underlying conditions and earnings not meeting expectations. The S&P 500 is now at approximately 5,800, with some analysts projecting levels as high as 6,600, but these optimistic forecasts prompt concerns about sustainability.
Super rallies and corrections in the S&P, driven by interest rate cuts and hikes (2016–2024).
Liquidity-driven super rallies, influenced by Fed policy on interest rates, are characterized by prolonged market increases with minimal price discovery. The first major super rally in the above chart followed the earnings recession of 2015-2016, fueled by tax cuts and global quantitative easing. Subsequent rallies occurred despite rate hikes, indicating a strong influence from central banks and government policies. These rallies often persist until liquidity conditions shift, such as through rate increases or unexpected events.
Currently, global central banks are signaling easing policies, contributing to the ongoing liquidity rally. Fiscal dominance, marked by significant deficits, plays a crucial role in this environment. The unprecedented $1.6 trillion deficit in 2023 raises questions about recession potential amid fiscal stimulus. Past experiences show that downside movements typically arise when liquidity changes. The current market situation highlights a disconnect between strong policy support and underlying economic conditions. Overall, these factors suggest that the rally extend through the end of the year or into 2025, but risks remain.
Reference:
Markets expect the Federal Open Market Committee to
cut interest rates again by 0.25% on Thursday, November 7.
The median S&P 500 return from October 27th to December 31st in election years is +6.25% since 1928.