Huge Divergences between Fed Funds, U.S. Notes/Bonds and Stocks

By the Curmudgeon with Victor Sperandeo

Fed Funds vs U.S. T-Notes and TLT:

Today, Zero Hedge posted on X: “This is the first time in history when 100bps of rate cuts raised 10Y yields by 100bps,” as per this chart:

The divergence is even greater than that if you substitute TLT (U.S. 20+ year bond ETF) for the 10-year T-Note:

Since Sept 17, 2024- One day before the Fed’s 50bps rate cut - TLT was at 99.44, but it dropped to a low of 86.98 on Dec 24th. That's a loss of 12.5% in a little more than two months!

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Stock Market Valuation at an Extreme:

While U.S. notes and bonds tanked since the Fed’s Sept 18^th 50bps rate cut, the S&P 500 and NASDAQ soared to the most overvalued U.S. stock market in history! Let’s look at a few measures of stock market valuation.

The chart below shows John Hussman’s most reliable gauge of market valuations in data since 1928: the ratio of nonfinancial market capitalization to gross value-added (MarketCap/GVA). Gross value-added is the sum of corporate revenues generated incrementally at each stage of production, so MarketCap/GVA might be reasonably be viewed as an economy-wide, apples-to-apples price/revenue multiple for U.S. nonfinancial corporations.

The chart below shows the relationship between MarketCap/GVA and actual subsequent 12-year S&P 500 average annual total returns, in data since 1928.

The next chart below shows Margin-Adjusted P/E, which considers cyclical variations in profit margins and their impact on the price/earnings ratio, along with the ratio of the S&P 500 to the present value of actual subsequent S&P 500 dividends at every point in time since 1900, discounted at a constant rate of 10% annually (see chart text for additional details). The ratio therefore estimates the extent to which likely long-term S&P 500 total returns are likely to depart from a 10% average return. The higher the valuation, the larger the expected shortfall from historically run-of-the-mill expected returns of 10%.

U.S. Stock Market Gains Limited to Big Tech:

From Robert Prechters’ Dec 18^th Elliott Wave Theorist (subscription required):

“While tech (stock) indexes get all the attention, the Dow averages quietly stopped rising two and three weeks ago. The Dow Jones Transportation Average in fact made its all-time intraday high three years ago, on November 2, 2021, but it made an all-time daily closing high on November 25, 2024. On the same day, the Russell 2000 index made its all-time intraday and daily closing highs, by a whisker above the highs of November 8, 2021. The Dow Jones Utility and Composite Averages made their all-time closing highs on November 26 and their all-time intraday highs on November 27. The Dow Jones Industrial Average peaked on December 4. Each average immediately entered a persistent decline despite later new highs in the tech heavy indexes.”

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Author’s Note:

The Dow Jones Industrial Average notched its longest daily losing streak in 50 years when it fell for a tenth straight session on Dec 18^th closing at 42,326.87. It’s been straight down since its Dec 4^th closing high of 45,014.04 with a Dec 26^th close at 43,325.80 .

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“Fitting the market’s selectivity, the daily advances vs. declines have been flat to negative the first twelve trading days in December. Down volume was higher than up volume on ten of those days. Peter Eliades of Stock Market Cycles alerted me to the fact that the cumulative a-d line broke a 13-month uptrend line in early December.”

And so it goes……………………………………………………………………………

Victor’s Conclusions:

While I agree with all of the above, I have one question about Fed policy. First, here’s a quote from a deep thinker from the 16^th century:

“I never met a man who thought his thinking was faulty.” by Michel de Montaigne, who was one of the most significant philosophers of the French Renaissance. He is known for popularizing the essay as a literary genre and his work had a direct influence on numerous Western writers. Montaigne’s massive volume Essais contains some of the most influential essays ever written.

Now the Question: Fed Chairman Jerome Powell has stated several times during FOMC meetings that the Fed is “DATA DEPENDENT.” Yet at their December 18^th meeting, the Fed lowered its dot plot [1.], from four to two rate cuts in 2025.

Note 1. The Fed’s dot plot is a chart that records each Fed official’s projection for the Fed Funds rate –the U.S. central bank’s key short-term interest rate. At the Dec 2024 Fed meeting, 10 FOMC participants forecast Fed Funds ending 2025 at 3.75% to 4%, three at 4% to 4.25%, also three at 3.5% to 3.75%. See Figure 2. Page 3. here.

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No one knows what incoming U.S. President Donald Trump’s trade/tariff, federal government spending and tax policies will be for the next year or if Congress will approve any or all of them. So how can the Fed now forecast there will be only two 25bps cuts in 2025 without knowing what the economic data will be next year?

àHow does that align with being data dependent or is the Fed now a fortune teller that can predict the future U.S. economy???

àHas Jerome Powell ever thought his thinking was faulty (Montaigne quote)? Perhaps he should look at the first graph in this article for a sanity check.

Closing Quotes:

This is the longest period of practically uninterrupted rise in security prices in our history… The psychological illusion upon which it is based, though not essentially new, has been stronger and more widespread than has ever been the case in this country in the past. This illusion is summed up in the phrase ‘the new era.’ The phrase itself is not new. Every period of speculation rediscovers it… During every preceding period of stock speculation and subsequent collapse business conditions have been discussed in the same unrealistic fashion as in recent years. There has been the same widespread idea that in some miraculous way, endlessly elaborated but never actually defined, the fundamental conditions and requirements of progress and prosperity have changed, that old economic principles have been abrogated… that business profits are destined to grow faster and without limit, and that the expansion of credit can have no end.

– Business Week, November 2, 1929

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There can be few fields of human endeavor in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present. Only after the speculative collapse does the truth emerge.

-John Kenneth Galbraith, A Short History of Financial Euphoria, 1990

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Wishing all our readers a wonderful Christmas season, joyous Hanukkah and Happy New Year!

The Curmudgeon
ajwdct@gmail.com

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies, and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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