US CPI & Year End Sentiment

Reassessment of Federal Reserve Cuts in the Market

The surge in the S&P500 has somewhat subsided in December, but the expansion of larger cap equities is evident, as the RTY and SPW have outperformed the SPX (313bps and 69bps) and QQQ (304bps and 59bps) this month.

The NFP data from last Friday confirmed the robustness of the labor market (see the assessment of our US Economics team here). However, holiday-related seasonal adjustments might conceal certain weak spots in the underlying market. Regardless of these potential risks, the investor community interpreted the strong employment data coupled with the payroll figures as an indication of a robust economy, thereby reducing the likelihood of Fed rate cuts. This was reflected in the 10Y yield’s 8bp increase on Friday alone, although risk assets were unfazed, with the SPX, NDX, RUT, HYG, and the Magnificent 7 all trending upward. Also, the VIX closed at its post-COVID low of 12.35, which stands at the 12th percentile relative to its historical record.

Strong NFP and unemployment pushed out the probability of rate cuts

Source: Citi Global Markets, Bloomberg, gray lines indicate probabilities for each meeting between Dec-23 to Dec-24

Macro Perspectives: Seasonal Tailwind for Small Caps

Although the impending CPI and FOMC events will be monitored keenly, we assert that seasonal factors significantly contribute to the year-end optimism, more so for small-cap stocks. Since 2002, the IWM ETF has averaged a return increase of +114bps during the last three weeks of December. This year, the said ETF saw a decline of -18% between July 31st and October 27th. Nonetheless, the recent upticks (+12% within the last month) have merely brought the index back in line with its historic trend, as illustrated in the chart below. This could potentially indicate a bullish sentiment as we approach year-end, all other factors being equal.

IWM averages +1.1% return in the final 3 weeks of the year between 2001–22

Source: Citi Global Markets, Bloomberg, gray lines indicate individual annual returns between 2001–2022