Resetting the stage: Jurrien Timmer on the current economic landscape

Political reset and economic implications

Timmer begins by contextualizing the political reset, drawing parallels with the 2016-2017 period. He emphasizes the importance of not being shocked by any outcome, a lesson he learned from previous political upheavals. The current administration, under President Trump, appears to be adopting an "all gas, no brakes" approach, with a clearer agenda than in 2016. This time, the administration seems poised to hit the ground running with a flurry of executive orders, potentially numbering in the hundreds, that could significantly impact trade and immigration policies.

Trade and immigration: market movers

Trade and immigration are highlighted as the two hot-button issues with the potential to move markets substantially. Timmer notes that recent softer tones on trade and tariffs have already influenced the US dollar, allowing markets to breathe more easily. This relief is crucial, as trade and immigration policies are known unknowns that can trigger significant market volatility.

Economic policies and market dynamics

Timmer discusses the economic policies expected from the current administration, including deregulation and tax cuts. Extending tax cuts remains a priority, but this raises concerns about financing. If extended tax cuts add approximately $5 trillion to the debt without corresponding spending reductions, it could lead to financing challenges that the Treasury market might not favor.

Interest rates and inflation

The Federal Reserve has cut rates by 100 basis points, bringing them close to a neutral rate, which Timmer estimates at around 4%. The Fed's terminal rate estimate stands at 3%, which he believes is too low given the current inflation trends. Core inflation, running at about 3%, suggests that the market and the Fed are aligned, with the forward curve reflecting a neutral rate of 4%.

Timmer points out that while the Fed has a couple of rate cuts on tap for the year, they are contingent on inflation moving decisively downward. The market is not eagerly anticipating these cuts, given the strong economic backdrop. However, the long end of the yield curve remains more crucial, with recent movements in the 10-year yield sparking significant market reactions.

Market sensitivity to long yields

The sensitivity of the market to long yields is evident. Timmer highlights a recent rally triggered by a decline in the 10-year yield from 4.8% to 4.65%, underscoring the market's heightened sensitivity to long yields over short rates. The shape of the yield curve, term premium, and long yields are poised to be defining factors for the market, much like trade and immigration policies.

Valuations and earnings

Timmer delves into market valuations, noting that the current environment is characterized by lofty valuations, with the S&P 500 yielding around 5%, comparable to bond yields. These competitive dynamic makes the stock market more sensitive to rate changes and movements in the bond market. He notes that the market environment is driven by strong earnings with tightening financial conditions. The current phase suggests a market that may be more prone to corrections, evidenced by a recent 5% correction driven by rate changes.

Breadth indicators and market health

Breadth indicators, such as the percentage of stocks in long-term uptrends, provide insights into market health. Timmer observes a notable deterioration in market breadth towards the end of the previous year, despite a recent uptick in the number of stocks above their 200-day moving average. He emphasizes the importance of market breadth for a healthy bull market, noting that oversold conditions in uptrends can present buying opportunities.

Earnings season and financial sector performance

Fourth quarter earnings season is underway, with 42 companies reporting so far, mostly from the financial sector. The results have been positive, with 87% beating estimates by about 10 percentage points. This robust performance is attributed to favorable conditions for banks, such as a steep yield curve and cheap funding. The growth rate for earnings coming into the season is around 8%, with expectations of reaching double digits for the fourth quarter and 10% for the year.

Global macro considerations

On the global front, Timmer touches upon China, suggesting it as a cyclical rather than a secular story. He likens China's current situation to Japan's in the 1990s, where rapid growth fueled by debt led to misallocation of capital. He advises a cautious approach to investing in China, viewing it as a market to rent stocks rather than own them long-term.

Conclusion