Rally has more room to run as investors get three green lights

The attempts by Federal Reserve officials trying to put the genie back in the bottle after the central bank last week juiced the rally by projecting at least three rate cuts look faintly ridiculous. Mohamed El-Erian is right – the Fed has a communications problem, and looks like it is being bullied by the market right now.

Bank of America’s final fund manager survey for the year suggests momentum can remain strong. Cash levels among fund managers continued to fall in December, to 4.5 per cent from 4.7 per cent in November and 5.3 per cent in October.

Professional investors are all-in on the Goldilocks story. Two thirds predict a soft landing for the global economy and 6 per cent expect no landing, 80 per cent expect lower inflation, and a record 62 per cent expect bond yields to be lower in 12 months time, suggesting rate cuts are coming.

Allocation to stocks versus allocation to cash has surged to levels not seen since January 22, but it’s nowhere near the sorts of levels we saw in 2021, when markets last peaked.

In other words, there appears to be room for the sharemarket rally to run now that investors have three green lights: a Fed forecasting rate cuts, bond yields retreating and still resilient economic growth.

The column still struggles to wrap its head around the idea that stocks could be nudging record highs less than nine months after Credit Suisse effectively ceased to exist in the middle of the worst banking crisis in generations.

The excesses of the last decade have clearly not been rung out of markets. We have not had the cathartic recession that typically resets the business cycle. Heck, we haven’t seen the full lagged impact of rate rises flow through.

But the euphoria we are seeing in global markets is hard to argue with – just ask the short sellers who’ve been forced to cover their positions like crazy.

It is too early to declare we’re in a bull market?

Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management certainly thinks so. She justifiably doesn’t quite get the Fed’s logic – “If we are truly in a soft landing already, do rate cuts really need to be pulled forward?” – but wonders whether the threat from demand-induced inflation is really gone. The Fed, she says, has failed to squash demand beyond home building; you could say the same for Australia.

Shalett’s party pooping extends to a history lesson. She points out that the Fed signalled pivots in the second half of 2000 and early 2007, before cutting some months later; on both occasions, stocks peaked and then plunged in the DotCom bust and global financial crisis, respectively.

But it’s Christmas, and no one likes a Grinch. The market’s mindset does appear to be changing, and investors appear likely to wait for evidence the soft landing scenario is at risk.

That’s fair enough.

But Shalett is right when she says that after this rally, the good news may be mainly priced in – “leaving the cost of disappointment high”.