After the Federal Reserve released its ** expectations on Wednesday, the market was jubilant. Foreign media analysis said that the current soft landing of the U.S. economy has become the most crowded transaction on Wall Street, but this may also be wishful thinking, because the expectations of investors in the past three years have been slapped in the face.
Even before the Fed's release on Wednesday, the consensus that the Fed would be able to cut interest rates aggressively next year without falling into a recession was already strong, and the Fed's new dot plot has strengthened that consensus. Investors see the Fed's ** and Powell's answer at the press conference as evidence of their belief that the Fed will initiate interest rate cuts when the economy smoothly transitions to a rare "soft landing".
Analysts believe that in the past three years, there have been many times of consensus among investors, but they have all been proven wrong in the end. At the end of last year, investors thought a recession was a foregone conclusion, the year before they thought big tech companies would be immune to interest rates**, and even further on they thought they would be profitable investing in popular stocks. And now, the market is once again convinced with absolute conviction that the economy will achieve a soft landing and interest rates will be lowered.
While investors may be right this time, they may not be. And if it turns out to be wrong, the market will penalize, as it has done in the past three years. If something other than a soft landing happens, the market will have problems, but there are now too many bets on a soft landing than just pricing, and this expectation has been fully or even over-absorbed.
Without any concern, investors re-aggressively re-surged the rate-sensitive ones that had been sold off earlier this year, with speculative tech and biotech stocks surging higher, while banks and real estate also performed well. The ARK Innovation ETF (ARKK) is 48% up since the end of October, 26% in the banking sector and 22% in the real estate sector.
* The rally has also extended beyond a handful of Big Tech winners in the AI boom, also during this time, when the equally weighted S&P 500 index outperformed the common market capitalization-weighted. And the Russell 2000, which has been struggling, has been up 20% since the end of October, as small businesses need to refinance heavily debt.
Investors have also turned from fear to greed in the options market. This week, the VIX index fell to its lowest level since pre-pandemic levels in 2020, and the ratio of put to call options to protect portfolios fell back to unusually low pre-pandemic levels.
According to the analysis, investors seem to have little concern that the economic slowdown could worsen further or that inflation could be more stubborn than expected. Signs of a negative impact on the real economy are seen as outliers, and investors are willing to bet that the recent slowdown in inflation will continue, even though inflation in the first two months was more than double that of the past two years.
However, in each of the past three years, a similarly strong consensus has emerged, which has ultimately been proven completely wrong. WhileEven if there is a soft landing next year, the gains may not be very large if you want to profit from something that almost everyone is betting on.
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