Goldilocks Hasn't Made It to Wall Street Yet

November was a wonderful month for investors. The Nasdaq and S&P 500 were up nearly 9%, their best monthly gains since July 2022 while the Dow gained over 10%. Now investors have quickly embraced the idea that the Fed Funds rate will be cut as soon as the first half of 2024 and that a "soft landing" will be achieved. I am not quite there yet.

In fact, if I cut through the good news of late, I still see much that gives me pause.

The primary driver of the November rally was the sharp decline in interest rates. After touching the 5% mark for the first time since July 2007 in late October, the yield on the 10-Year Treasury had fallen to just 4.33% by the end of the month. Yields are falling as inflation starts to ebb both here and abroad. European inflation rose only 2.4% in November, falling far faster than the 2.7% consensus in a report that hit yesterday. Core personal consumption expenditure index in October also cooled to 3.5% in October from 3.7% in September.

10-Year Treasury Yield During November

The recent fall in inflation and interest rates are welcomed, but in reality, they will be only of marginal help to consumers. Delinquency rates on credit card balances have hit levels not seen since 2011. Auto loan defaults are at their highest rates in decades. I don't see either trend reversing based on the fall in interest rates over the past month, especially as the jobs market continues to deteriorate.

The corresponding fall in mortgage rates over the past month will also be of marginal help to the housing market. CNN had a piece earlier this week around a report from the Atlanta Fed that postulated that even if mortgage rates fell all the way down to 5%, housing affordability would still be extremely challenged. To get back down to average historical housing affordability, either average wages would have to rise by 25% or housing prices would need to fall by 25%. If I had to bet, most of any equilibrium being reached sometime on the horizon will mostly be achieved by falling home prices. As was pointed out by a post on the Daily Diary Thursday, owning a home is now 52% more expensive across than nation than renting on average. An all-time high.

Falling rates will also be helpful for the Federal government in servicing the massive and fast-growing national debt. But it is not going to be a panacea. Nearly a quarter of the national debt needs to be refinanced over the coming year. The average weighted interest rate to service that debt stood at just over 2.9% at the end of the government's fiscal year on September. This means the cost to service this debt will be far more than $639 billion spent to do the same in fiscal 2023, even it looks like it will be less than it was a month ago thanks to the fall in rates.

I also see the recent fall in rates doing little to help out the beleaguered commercial real estate sector and I expect delinquency and default rates to continue to rise as some $540 billion in CRE debt needs to be rolled over in 2024.

The $64,000 question for investors if whether the recent decline in inflation and the correspondingly drop in rates is the result of monetary policy achieving its end goals or whether it is a sign that the economy is slipping into a recession. Bulls will point to the 5.2% GDP growth in the third quarter confirming the former. Bears will say that the last time GDP growth of 5% occurred was in the fourth quarter of 2021, which then was immediately followed by two quarters of GDP contraction.

My view is that we are going to find out which thesis is correct by the end of the first quarter of 2024 and I remain cautious on the overall market until more signs of a soft landing are forthcoming.

Positions: None

At the time of publication, Jensen had no position in any security mentioned.