Bond Market's License to Thrill

Here are some of the biggest stories from last week:

• Wall Street strategists are scrambling to update their 2024 targets for the S&P 500.
• US bonds notched their best monthly performance in nearly four decades.
• The price of gold hit a record high at the start of the week.
• Bitcoin surged past $40,000 for the first time in nearly 20 months.

Dig deeper into these stories in this week’s review.

Stocks

In a move no one saw coming, the S&P 500 snapped a three-month losing streak in November to post its best month in almost a year and a half. Investors were happy to look past geopolitical turmoil, high borrowing costs, and the possibility of a recession to push the index 8.9% higher last month – its second-best November since 1980, behind only the vaccine-fueled rebound during the height of the pandemic in 2020. That surprise rally has Wall Street strategists scrambling to update their 2024 targets for the S&P 500, with some calling for new record highs while others warn of a nasty drop.

On one end, you have Bank of America, Deutsche Bank, and BMO Capital Markets among those who see the index hitting 5,000 or higher next year. (The S&P 500 touched a record high of around 4,819 on January 4, 2022). On the other end, you have JPMorgan, which expects the index to drop to 4,200 by the end of 2024 – roughly 8% from its current level. The bank attributes that bearish call to decelerating global growth, shrinking household savings, rising geopolitical tensions, and increasing political uncertainty in the US stemming from the country’s national elections next year.

All in all, the average 2024 target of all the strategists tracked by Bloomberg currently sits at around 4,664, representing a measly 2% gain in the S&P 500. But take those forecasts with a big grain of salt, as Wall Street strategists tend to get it wrong quite often. In fact, many were warning just 12 months ago that higher interest rates would trigger a recession and crater the stock market, only to be blindsided by this year’s ferocious rally. At the end of the day, the wide-ranging predictions for the S&P 500 in 2024 reflect the dynamic and often surprising nature of the stock market, offering investors a cautionary tale about the perils of overconfidence in forecasting.

Bonds

It’s remarkable how fast sentiment can change in the bond market. Less than two months ago, the 10-year Treasury yield hit 5% for the first time in 16 years after investors dumped bonds en masse, sending their prices lower and forcing their yields higher. The rout, which threatened to put Treasuries on course for an unprecedented third year of losses, had been going on for weeks, fueled by expectations that the Fed would keep interest rates at their current high levels for longer and that the US government would have to sell even more bonds to cover its widening budget shortfall.

But growing signs that the economy and inflation are both slowing have fueled expectations that the Fed is done hiking interest rates, sending investors rushing back into the bond market. In fact, the Bloomberg US Aggregate Bond Index – a key benchmark that tracks the performance of a wide range of US investment-grade bonds, including government, corporate, and mortgage-related bonds – just notched its best month in nearly 40 years after rising 4.5% in November. The surge pushed the 10-year Treasury yield 0.6 percentage points lower during the month, to 4.33%. And since this yield is often used as the risk-free rate to price all other investments, its decline led to a powerful rally in every other asset class last month, from stocks to crypto. The MSCI All-Country World index, for example, rose 9% in November, marking the global equities benchmark’s best month in three years.

The key question now is whether the rally can be sustained. Traders are currently pricing in about 1.25 percentage points of US rate cuts next year, with the first one expected at the central bank’s May meeting. That would seem like a clear path for lower yields and an extended bond market rally. But Fed officials have repeatedly warned that it’s premature to start thinking about interest rate cuts, and are instead trying to hammer home the notion that rates will remain higher for longer, until inflation is convincingly back on target. So if the central bank doesn’t deliver the rate cuts the market is hoping for, then investors should brace themselves for a big move higher in Treasury yields. After all, bond market sentiment can change in the blink of an eye, and traders have been burned before betting on rate cuts prematurely.

Commodities

Gold briefly jumped more than 3% on Monday to hit a record $2,135 an ounce, surpassing the previous all-time high it set in August 2020. The latest rally comes as bond yields and the dollar fall amid growing expectations for US rate cuts early next year. See, like most internationally traded commodities, gold is priced in dollars. So when the dollar weakens compared to other currencies, gold becomes cheaper for most of the world to buy – increasing international demand and pushing up the metal’s price. Falling bond yields, meanwhile, decrease the “opportunity cost” of owning gold (instead of bonds) since the metal doesn’t generate income.

But there are a few other factors driving gold’s strength this year. First, demand for the precious metal has been propped up by record buying from central banks over the past 18 months, as some countries looked to diversify their reserves to reduce their reliance on the dollar after the US weaponized its currency in sanctions against Russia. Central banks globally have bought a record 800 tonnes of gold in the first nine months of 2023, up 14% from the same period last year. Second, gold's reputation as a safe-haven asset has recently bolstered its performance amidst rising geopolitical and economic turbulence, with two ongoing wars and 41% of the world’s population due to go to the polls next year.

Crypto

Crypto investors had something to celebrate at the start of the week after the price of bitcoin surged past $40,000 for the first time in nearly 20 months. The world’s biggest cryptocurrency was last at these levels in April 2022, before the TerraUSD stablecoin collapse accelerated a $2 trillion rout in digital assets. Bitcoin is now up by more than 150% this year (its biggest annual gain since 2020), with the recent rally being driven by a few factors. First, the investor push into crypto follows a recent rush into stocks, bonds, and gold, fuelled by growing expectations that the Fed will soon cut interest rates.

Second, the possible approval in coming weeks of the first US spot bitcoin ETFs – something firms like BlackRock, Fidelity, Invesco, Grayscale, and WisdomTree have been trying to get authorized for years – is fueling increased speculation for the cryptocurrency. These proposed funds would let investors access bitcoin by simply purchasing shares, similar to buying stock, eliminating the need to own the crypto in a digital wallet. That whole new way to easily invest in bitcoin without directly owning the asset could lead to increased demand, boosting its value. That’s why traders are buying in anticipation of the potential US approval of the first spot bitcoin ETFs.

Third, the bitcoin halving due next year is providing a big boost to sentiment. A bitcoin halving occurs roughly every four years, reducing the reward for mining new bitcoin blocks by half. This process is a part of bitcoin's monetary policy, designed to uphold the value of the crypto by decreasing the rate at which new bitcoins are created, until it hits its maximum fixed total supply of 21 million coins in 2140. The price of bitcoin tends to bottom 12 to 18 months prior to each halving before going on to hit new record highs – a dynamic seen in each of the last three halvings.

Fourth, bitcoin’s correlation to other asset classes has fallen this year, increasing the crypto’s appeal as a portfolio diversifier. The 90-day correlation coefficient for bitcoin and MSCI’s index of world shares, for example, has dropped to 0.18 from 0.60 at the start of the year. A similar study for the crypto and spot gold shows the figure has declined to about zero from 0.36. 

Next week

• Monday: Earnings: Oracle.
• Tuesday: UK labor market report (November), US inflation (November).
• Wednesday: Fed interest rate announcement, China foreign direct investment (November), UK monthly GDP (October), eurozone industrial production (October). Earnings: Adobe.
• Thursday: ECB interest rate announcement, BoE interest rate announcement, US retail sales (November). Earnings: Costco.
• Friday: China retail sales and industrial production (November), eurozone, US, UK, and Japan PMIs (December).