Wave of takeovers adds to bullish sentiment on markets

Central bank pushback on market pricing of aggressive interest rate cuts won’t stop the strong year-end rise in stocks.

Central bank pushback on market pricing of aggressive interest rate cuts won’t stop the strong year-end rise in stocks despite some tempering of bullish sentiment in the US.

In Australia, a wave of takeover activity is adding to that bullish sentiment. About $5bn of takeover offers were announced on Monday on top of much bigger plays on Santos and Perpetual this month. After a weak year for M&A, the smart money is now seeing value as the rate cycles turn. A pick-up in M&A could be a bullish factor next year.

As far as financial markets are concerned, the rapid disinflation of the US economy now means interest rates can fall sharply even as the world’s biggest economy avoids a recession.

This is happening at the most bullish time of year for stocks.

US investors won’t be inclined to take profits before December 31. By booking profits after year end, they can push related tax payments out to April 2025.

US economic resilience has been a surprising feature for most of this year. Citi’s US economic surprise index has surprised positively since early February.

Bloomberg’s consensus estimate of US recession probability for the next 12 months has fallen steadily to 50 per cent this year, from a peak of 68 per cent in January. Of course, US recession bets are still relatively high after the fastest rate rising cycle since the 1970s. But it’s becoming hard to find a top US strategist still forecasting a recession next year.

Also, for most of this year US economic resilience was seen as “bad news” for the interest rate outlook. With US inflation coming down rapidly, the emerging view is that US corporate earnings will hold up along with valuation in a “soft landing” scenario of interest rate cuts and no ­recession.

US recession probabilities have continued to fall in recent months, but the biggest change has been the downshift in interest rate expectations, notwithstanding a minor lessening of such hopes after Friday’s comments from Fed officials John Williams, Raphael Bostic and Austan Goolsbee. Williams told CNBC it was too early for officials to begin thinking about lowering borrowing costs as they considered whether policy was restrictive enough to get inflation back to 2 per cent.

“We aren’t really talking about rate cuts,” Williams said.

He said March would be too soon for the Fed to think about cutting interest rates.

Financial markets reacted “more strongly” than policymakers showed in their rate projections. “The market in a way is reacting very strongly, maybe more strongly, than what we are showing in terms of our projections,” Williams added.

“It is just premature to even be thinking about that question.

“That’s not the question in front of us.”

Capital Group senior financial market analyst Kyle Rodda said the fact that Williams led this “push back” by Fed officials was “telling because his commentary a few weeks ago about the case for lowering rates as inflation falls to keep real rates steady fuelled the euphoria about cuts”.

“The mixed messaging raises the question of whether the Fed has fumbled its communication and potentially scored an unfortunate own goal as financial conditions loosen as a result of the new forward guidance,” Rodda said.

US financial conditions last month loosened more than any month in the past four decades, according to the Goldman Sachs US Financial Conditions Index – which uses inputs such as the level of the stockmarket, bond yields and interest rate spreads. That move has continued this month.

Bostic, who votes on monetary policy next year, told Reuters he expected two US rate cuts next year but not starting until the September quarter. “I’m not really feeling that this is an imminent thing,” he said, adding that policymakers would need “several months” to get enough data and confidence that inflation would continue to fall.

Importantly for the short-term outlook for financial markets, the view that the US will have rate cuts along with continued growth next year is only just becoming a consensus view.

After a “scorching” rise from the October lows, the risk-reward equation for stocks is “more demanding” in regard to investor sentiment and risk premium, according to Goldman Sachs.

“Therefore, I wouldn’t constrain my imagination at this time of the year, I expect that an extension of the rally from here will display less velocity than what we’ve seen over the past two months,” said New York-based Tony Pasquariello, global head of hedge fund sales at Goldman Sachs.

He said a fair bit of “length” had been added over the past two months, but the flow of funds would remain skewed to the buy side. US retail investors had “clearly gone into buy mode” and discretionary hedge funds were only modestly long before last week’s surge in US stocks.

He noted that over the past two years, any significant easing of US financial conditions was met with a “fight” from the Fed because it worked against the Fed’s policy tightening.

But “that cat-and-mouse game is over”. He said he now thought easier financial conditions were set to support economic growth, which “should provide a floor to risky assets”.