Transcript: Markets gone wild

This is an audio transcript of the Unhedged podcast episode: ‘Markets gone wild’

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Katie Martin
What the heck just happened? Since the Fed meeting last week, markets have gone bananas. We’ve already busted through a lot of targets that investors and analysts had for 2024 because stocks and bonds are going to the moon. What on earth is going on? We’re gonna help you figure it out, hopefully.

This is Unhedged, the markets and finance podcast from the FT and Pushkin. I’m Katie Martin, the markets editor in London, and I’m inexplicably not joined by Ethan Wu, who has been allowed to go on holiday, or something?

Robert Armstrong
We do let the young people out of the office once in a while.

Katie Martin
What the? Who’s gonna do all the work?

Robert Armstrong
We are kind and beneficent overlords.

Katie Martin
Rob Armstrong over there in New York. You are indeed kind and generous in New York, writing your Unhedged newsletter, but you’re not as kind and generous as Jay Powell, chair of the US Federal Reserve. What has he done?

Robert Armstrong
I think of Jay as a very restrained and even-tempered fellow. But I think in that press conference last week, he came very close — and this is a good New York word — to kvelling about the state of the economy.

Katie Martin
I’m sorry. What now?

Robert Armstrong
Bristling. I think that’s a Yiddish word. I’m not sure. But when you kvell, you kind of bristle with pride. It’s like the parent at the kid’s sporting event after the kid scores a goal. They kvell. He was this prideful, like, he got opportunities to be his usual dour self. You know, reporter says, well, if you do cut rates as many times as you expect next year, as much as the committee expects this year, is that because the economy is slowing? No. Basically, what’s the answer? It’s because inflation is coming under control.

Katie Martin
Let’s just rewind a tiny bit, though. So the Fed left rates on hold. Still, you know, 5 per cent and change. But there was some new stuff that came to light . . . 

Robert Armstrong
The dots.

Katie Martin
 . . . which includes the dots. Everybody loves the dots. So for those who are not familiar, Fed rate setters put little dots on a chart to show where they think rates can or should be at certain points in the future. And you can get a little bit kind of horoscopey about the dots, honestly. But the dots are the best kind of guide we have as to what the Fed is gonna do next. And those pretty little dots . . . 

Robert Armstrong
Those dots moved. They moved a lot. So in the last set of dots, which came in September, there were still a couple of members of the Fed’s Open Market Committee, the rate-setting committee, who were way out saying rates are gonna have to be . . . in 2024 there were a few of them still stamping their foot and saying rates are gonna have to be higher still in 2024. And the group as a whole thought, you know, we were gonna be in that 5 per cent range into 2024. And then all those outlier hawks have been shot out of the sky and everybody moved down to the 4 per cent range, right? So there was, like, this big change in the outlook.

Katie Martin
And as you say, Jay Powell, he’s not one to pass up an opportunity to be a bit miserable, but instead he was saying, first of all, victory lap, all those bozos who said we were heading into a recession were wrong. And there was just kind of quite a sort of no, no, no, you messed this one up.

Robert Armstrong
He did nod to the fact that things can still go wrong. But it was, as I said, by his standards, quite demonstrative.

Katie Martin
But he was also saying, OK, sure, inflation is still above target, but we don’t have to wait for it to hit 2 per cent before we start cutting.

Robert Armstrong
And in fact, he cautioned against waiting until everything was exactly at the 2 per cent target before they started to ease policy.

Katie Martin
And what was the phrasing? Rate cuts are coming into view? Or the discussion of rate cuts is coming into view?

Robert Armstrong
Yes. We’re not talking about it, but we’re thinking about talking about it. And that wasn’t his phrase. But that is as best as I could tease out the message. Now, but the real point, the most salient point for this discussion is not what Jay Powell said or what we heard him say, but what markets heard him say. The markets heard him doing backflips and playing a little trumpet. So he allowed as how the Open Market Committee thinks there’s going to be three rate cuts. That’s their aggregate judgment, is three rate cuts for next year.

Katie Martin
Next year, yeah.

Robert Armstrong
And the markets said, did you hear him? He just said six.

Katie Martin
(Laughter) Yeah.

Robert Armstrong
And so now, the market expects the federal funds rate to fall below four next year. So that’s six, five, six cuts. And correspondingly, every risk asset that is not nailed down has leapt up off the floor and is doing a little dance around.

Katie Martin
You are enjoying your dances and backflips today, Rob Armstrong. Must be . . . 

Robert Armstrong
I just try to keep things lively. It’s the Christmas season.

Katie Martin
. . . the Christmas sherry. So the market is doing some weird stuff, some stuff that makes sense and some stuff that makes less sense. The stuff that makes sense is that if the market really does think we’re gonna get six rate cuts next year, then accordingly, government bond yields have collapsed. And that kind of makes sense if that’s what the market thinks, even if that’s not necessarily what the Fed thinks about how far they’re gonna go. So government bond yields collapsed because prices have gone up so much and we’re right back at levels that we haven’t seen since at least the summer, since everyone was talking about higher for longer. And stocks have shot up to very close to all-time highs.

Robert Armstrong
Yeah, we’re right up against the all-time highs. Yeah.

Katie Martin
So it’s kind of right, crisis over. So the funny thing is, though, right? We can talk about this more later on, but these things don’t make a lot of sense together, so what . . .?

Robert Armstrong
Let’s talk about it right now. So either growth is going to be good, in which case the Fed is going to be cautious about how many times it cuts rates, or growth is going to be less good and the Fed will cut more. That’s how I would frame reality. What the market seems to be hearing, and we’re not the only ones to point this out, by the way, is that growth will be good and the Fed will not be cautious about cutting rates.

Katie Martin
So you’ve got all these kind of, you know, unicorns there at their Bloomberg terminals trading away with their little hooves and they’re saying, OK, so the Fed is gonna cut rates six times, but there’s not gonna be a recession, so buy stocks. And one of these sets of people has got to be wrong here, right?

Robert Armstrong
I think that’s probably true, although there is a more benign interpretation of what markets are doing, which is that they are kind of cutting the worst-case scenario out. So the stock index that has risen the most of the major ones is the Russell 2000 stock index, which is where we put our small stocks in America and increasingly, our small, crappy stocks.

Katie Martin
Value. Value — that’s the word, Rob.

Robert Armstrong
Value. I’m sorry, that’s what I meant to say. A lot of these stocks have balance sheets that are highly levered, therefore are rate-sensitive. And since Jay opened his big mouth last week, those stocks are up like 6 or 7 per cent, which is a huge move in just a couple of days. So it’s like, the stocks that would have been in the most trouble if something bad had happened in ‘24 are the ones that are moving the most. You could interpret that as markets saying, well, the Fed’s not gonna tighten us into a recession. Inflation is kind of under control. The really bad stuff is not gonna happen and that should give us a couple of more per cents. It doesn’t mean next year is gonna be all rainbows, crumpets and jam, snow days and whatever kind of good things you have over there in England. But it does mean that the worst scenarios have been eliminated.

Katie Martin
But like some of the investors that I speak to are like, OK, so you got this incredibly benign set of circumstances all baked into market pricing. This makes me nervous. Firstly, because we’ve already busted through where I thought we would end 2024, never mind 2023. But also, when you’ve got markets that are priced for perfection, it doesn’t take very much to tip things into imperfection and for bad things to happen. This is what people are worried about. Now, Rob, I’m told that you know how we always ask in these situations, hey, Rob, what can go wrong? Apparently that makes us terrible people because journalists are always trying to think about things that go wrong. Nonetheless, what are the challenges here, Rob Armstrong? Several spring to mind for me. But you go ahead.

Robert Armstrong
OK, so stocks have become expensive again. One of the great things we might have said at the beginning of 2023 is that stocks looked pretty reasonably valued. So the S&P 500, as I remember, was at something like 18, which is kind of historically normal. Now it’s at something like 22 times earnings. At 22, you’re thoroughly on the expensive side. And even more importantly than that, the seven stocks that are doing all the work to keep that index up, the Magnificent Seven, the salubrious seven, the sexy seven — Amazon, Microsoft, Apple, Alphabet, Meta, Nvidia. Have I missed any? I think I got most of them, anyway. These stocks are very expensive indeed. So that’s your point about perfection being difficult. Things that go wrong — we can get a one or two slightly spooky inflation reports and . . . 

Katie Martin
That’s the thing.

Robert Armstrong
And everybody realises it’s not gonna be six cuts, it’s gonna be three or it’s gonna be two. The history of inflation in America is not a history of a line that goes straight up and then comes straight down. It is the history of lines that oscillate. And the Fed is very aware of this fact and has mentioned it on several occasions. And so if they get even a hint that there is gonna be an accelerating pattern of inflation, they’re gonna change their attitude very quickly because the only thing worse than being the Federal Reserve Open Market Committee that didn’t see in time that inflation was serious is being the Federal Reserve Open Market Committee that defeats inflation and then lets it ramp up again.

Katie Martin
Yes, nobody wants that.

Robert Armstrong
Nobody wants to be remembered in history as that group of people.

Katie Martin
The main things that can go wrong do fall into those buckets, right? One is that the inflation monster has not been vanquished after all, and that it comes back and you get like one kind of toppy inflation number, you know (overlapping audio).

Robert Armstrong
It doesn’t have to go back to six, right? It just has to tick up a little bit and get the Fed thinking. And this exuberant rally is going to be killed dead.

Katie Martin
Or we do get the recession that everyone has wrongly been saying is gonna come any day now for at least a year. And then stocks kind of shouldn’t be up where they are again, kind of relating to your valuations point.

Robert Armstrong
So the point you’re making is that we’re not in that different a situation than we were before.

Katie Martin
But there’s other stuff that can go wrong. There’s an awful lot of politics next year. What is it, like, 40 per cent of the population of the earth is going to be subject to an election next year. This might include the rainy little island of the UK.

Robert Armstrong
Yes. It definitely will include the massive continent of the United States. Here’s a prediction for you, though, Katie. I don’t think any of the politics is gonna matter. My view about markets is that they don’t understand politics very well. Perhaps because nobody understands politics very well and therefore they have a strong tendency to pretend like nothing has happened. You know, we did get a rally when Trump was first elected because corporate tax cuts were such a big part of his agenda. But I think that was kind of anomalous. Like, I don’t think the market is gonna make many bets on the fiscal policy or the central bank appointees of the relative presidents. I think, you know, the market is just gonna ignore the whole thing. I mean, we have been harping on this things going wrong stuff. But I’m seeing the way through. The economy is slowing, inflation is coming down. So we do have a kind of Goldilocks combination of slowing inflation, slowing but still positive growth. Stocks are expensive, but they don’t look bubbly per se. And I don’t know, I just feel like there is a way through here and I say fie on your most negative predictions.

Katie Martin
I’m not super negative. But I do think that there is a possibility that the bond market is right for the wrong reasons in the sense that maybe there is something that looks and smells a lot more like a recession coming over the course of next year, in which case six rate cuts arguably would make sense. But again, maybe the stock market is not wrong either in the sense that, you know, everyone’s been saying for as long as I’ve been in financial journalism, which is an alarmingly long time, that, you know, oh, well, any day now the market is going to start rewarding companies based on their fundamentals, and it’s going to be about earnings and it’s not gonna be about just multiples. And it’s like, it’s multiples, guys. It’s always multiples. (Robert laughs) Just because something is overvalued, it can stay there.

Robert Armstrong
I would say that the bond market, I agree with you, the short end has moved pretty dramatically. However, the long end, the 10-year Treasury is still at almost 4 per cent. I think it’s 3.9 this morning.

Katie Martin
3.9.

Robert Armstrong
That is not necessarily a recessionary level.

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Katie Martin
Yeah. Gonna be an almighty battle next year between the Fed and the markets and I am here for it. I’m sure you are, too. But we are gonna have to wrap it up there. We’ll be back in a sec with Long/Short.

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OK, it’s time for Long/Short, the part of the show where we go long a thing we love, short a thing we hate. Rob, what you got?

Robert Armstrong
It’s been a terrible year for fraud and deception.

Katie Martin
What, not enough of it?

Robert Armstrong
No, I mean, it’s just been so unsuccessful this year. So we’ve had FTX and Sam Bankman-Fried convicted, George Santos thrown out of the House of Representatives, something that was . . . 

Katie Martin
He’s good value, isn’t he?

Robert Armstrong
Yes. The Nikola CEO was convicted of deceiving investors. A Vatican cardinal got convicted. It’s been a very difficult year for fraud and deception. And so I think we’re gonna revert to the mean and I’m gonna go long fraud for 2024. I think it’s gonna be a great year for cheats and liars in 2024.

Katie Martin
For getting away with it.

Robert Armstrong
For getting away with it. Rudy Giuliani too, $148mn. I mean, what is a liar to do in today’s world?

Katie Martin
Difficult times. I am short — I don’t hate them, but I’m short of them — Christmas cards. What has happened to Christmas cards? I used to get lots of Christmas cards. Either I’m suddenly very unpopular, which is definitely possible, or people are not sending them anymore. And I think people are not sending them anymore. And I know this because I haven’t received one from my grandmother.

Robert Armstrong
Have you considered the fact that she just doesn’t love you anymore, Katie?

Katie Martin
It’s definitely possible but, you know, in fairness, she’s 100 years old. Hello, Grandma, happy Christmas. I don’t think she listens to this show. But maybe when you’re 100, you don’t bother writing Christmas cards anymore.

Robert Armstrong
Maybe not.

Katie Martin
But normally, by like the 5th of December, I’ve got one from Grandma and I haven’t got one this year. So I think people are just not sending them anymore.

Robert Armstrong
My mantel is bare as well.

Katie Martin
It’s a decline in moral values and/or my levels of popularity with my own family.

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So yeah, short Christmas cards, they had a good run, but it seems like they’re kind of over. We, as a beautiful segue, are over for today. Rob, it’s been a pleasure.

Robert Armstrong
Of course.

Katie Martin
And we will catch up again, no doubt very soon. Unhedged is produced by Jake Harper and edited by Bryant Urstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhecz. Cheryl Brumley is the FT’s global head of audio. Special thanks to Laura Clarke, Alastair Mackie, Jacob Weisberg and Jess Truglia.

FT Premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available for everyone else. Just go to FT.com/unhedgedoffer. I’m Katie Martin. Thanks for listening.

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