Market Outlook: Navigating Year-End Chop and 2025 Uncertainties
As we wrap up the last macro week of 2024 and look ahead to 2025, the financial markets are presenting a complex landscape filled with both challenges and opportunities. Let’s dive into the key themes and insights from our recent market review.
Choppy Waters: Year-End Market Conditions
The final days of 2023 are proving to be anything but calm. Markets are experiencing significant choppiness, characterized by:
- Sharp sell-offs at market open, followed by rallies
- Weak closes, particularly on Fridays and Mondays
- Poor market breadth, but high dispersion among individual stocks
This volatility is largely attributed to two factors:
- Pension fund rebalancing, estimated to be in the 87th percentile of historical levels
- Options expiration, with a large gamma expiry set for December 31st
The result? A trading environment that’s not for the faint of heart. It’s a time for caution, especially when it comes to putting on significant risk.
Sector Spotlight: Winners and Losers
In this choppy market, we’re seeing clear divergences among sectors:
- Consumer cyclicals are leading the declines
- Energy stands out as a bright spot
- Over the longer term (3-12 months), communications, consumer cyclicals, tech, and financials have been top performers
- Basic materials, healthcare, and real estate have struggled, impacted by higher interest rates and China’s economic slowdown
Federal Reserve: A Shifting Landscape
The Fed’s stance has undergone a significant shift in recent months:
- No rate cut is expected in January (88% probability)
- Markets are now pricing in only 39 basis points of cuts for 2024, down dramatically from 125 bps previously
- A survey of market participants shows most expect between 0-50 bps of cuts in 2024
Source: https://www.spectramarkets.com/amfx/trudeau-poilievre-scaled-tariffs/
This pullback in rate cut expectations has hit certain markets hard, like the Russell 2000. However, the S&P 500 and Nasdaq have shown resilience, seemingly pricing in a “Fed put” scenario where emergency cuts could come if financial stability is threatened.
It’s worth noting that this reliance on the Fed put may be misplaced. With inflation concerns still present, the Fed’s ability to aggressively cut rates could be limited in 2024.
Currency Outlook: Dollar Dominance?
In the currency markets, expectations are tilting towards:
Source: https://www.spectramarkets.com/amfx/trudeau-poilievre-scaled-tariffs/
- USD as the best performer
- CAD and EUR as potential underperformers, largely due to tariff threats
- AUD showing strength, interestingly disconnected from bearish China views
Tariffs: The Wild Card for 2024
Tariffs are shaping up to be a major focus for 2024. Several scenarios are on the table:
Source: https://www.spectramarkets.com/amfx/trudeau-poilievre-scaled-tariffs/
- Most likely: 10% global tariff with threats of escalation
- Extreme scenarios: 60% tariffs on China or 25% on Canada/Mexico (seen as less probable)
- Threats and tweets without actual implementation
The market impact will vary by scenario, but we can expect initial volatility followed by potential rallies if moderate measures are implemented.
China: Engineering Growth Amidst Challenges
China’s economic situation remains complex:
- As a managed economy, China has levers to engineer growth if desired
- Unlike Japan’s “lost decade,” China is not seen in structural decline
- However, onshore investment carries significant risks due to potential government intervention
- Stimulus is likely, but constrained by concerns over capital flight
For investors, the key is to focus on China’s impact on global markets (e.g., AUD, commodities) rather than direct onshore investments.
Trading Strategies for the Road Ahead
Given the current market conditions, consider these strategies:
- Bear call spreads on companies in a downtrend or put ratio back spreads on MSTR to play a reset in exuberance in January
- VIX options strategies (bull call spreads) which have been holding value well
- Caution on credit spreads in January due to expected volatility
- Look to February/March VIX expiries for potential opportunities
Next Steps: Navigating the Weeks Ahead
As we move into 2024, keep these points in mind:
- Expect choppy, illiquid trading conditions through year-end
- Closely monitor January economic data, especially payrolls
- Pay attention to Fed communications for clues on future policy
- Prepare for potential market volatility around January 20th (inauguration/tariff announcements)
- Reassess credit spread strategies after January volatility settles
Remember, in times of uncertainty, patience and careful analysis are your best allies. Stay informed, stay nimble, and here’s to a prosperous 2025!
