It is not known how many investors have actually read the fairytale “Goldilocks and the Three Bears”. What is for sure is that this story once again serves as an explanation for strong equity markets. In the fairytale, Goldilocks finds herself in the house of the three bears. Among the things she sees is porridge that is neither too hot nor too cold. The stock market analogy is that the economy is performing robustly without overheating. In such an environment it is riskier investments, particularly shares, that are in demand. Reuters’ English-language reports on the stock market have used the word “Goldilocks” almost 120 times in the last three months. Over the same period the S&P 500 index has appreciated in value by more than a tenth. At the beginning of February, the US benchmark climbed above the 5,000 point mark for the first time in its nearly 70-year history. The “fairytale” record chase correlates closely to monetary policy, with investors betting on the US central bank inaugurating a cycle of rate cuts in the near future.
Alongside the buzzword “Goldilocks”, however, the expression “higher for longer” is also a firm fixture in Wall Street reports. To put it plainly, USD interest rates could still linger at a high level for some time to come. “The job is not done,” is the mantra of Fed chairman Jerome Powell. He never tires of pointing to the data, stating that the US central bank would like to see more evidence that inflation is actually heading back towards the target level of 2%. It was precisely these expectations that were recently dampened when the rate of inflation in the USA at the start of the year decreased by less than anticipated. In January 2024, the Consumer Price Index (CPI) rose by 3.1% on a 12-month view. Economists had on average expected a rate of 2.9%. While petrol prices have fallen, US consumers have had to dig much deeper into their pockets for transport services and restaurant meals.
On Wall Street, the most recent report from the Bureau of Labor Statistics caused only a momentary shock. The S&P 500 index slipped below the 5,000 mark, but the benchmark had recovered the ground again within two trading sessions. Yield levels remain high: at 4.28%, the interest rate on 10-year US bonds is more than 40 basis points above the figure for the end of 2023. On top of this comes a shift in expectations of monetary policy. If the CME Fed Watch Tool is to be believed, investors will have to bide their time until 12 June, the day on which the Fed could cut interest rates for the first time. Just four weeks ago futures markets were pencilling this step in for as early as 20 March. Should there be further upside surprises in terms of inflation, one or two bulls could start to think long and hard about the “higher for longer” scenario – all the more so given that the S&P 500 is anything but cheap following the latest rally. According to Factset, the price-earnings ratio (PER) for the index at the start of February was over 20 for the first time in almost two years. That means the key valuation ratio exceeded its 10-year average by nearly 15%.
The latest rises in yields and in the US dollar have not left gold unscathed either, with the price of a troy ounce having since fallen below the USD 2,000 mark. Even so, the safe haven currency is only around USD 65 off its closing rate for 2023, the highest ever recorded for the last day of the year. As soon as the Fed actually loosens the reins, it could be time for a new upward trend in gold prices. That is also what the bulk of analysts think. According to a survey conducted by Reuters at the end of January, the average expected price for the 2nd quarter of 2024 is USD 2,050. Looking ahead to 2025, more than a few research firms reckon the troy ounce could reach quotations of USD 2,100 or more. Assuming that the precious metal does actually head for new record highs while the air goes out of Wall Street somewhat, now could be the time for a long/short strategy on the Gold/S&P 500 duo.
Source: U.S. Bureau of Labor Statistics; as at: February 2024 Past performance is not a reliable indicator of future performance.
*no FED meeting in April and August 2024 Source: CME FedWatch Tool (CME Group); as at: 18.02.2024 Past performance is not a reliable indicator of future performance.