XBI - When Doves Fly And The Bulls Run

2023-12-14 13:22:45 ET

Summary

• The Federal Reserve's Open Market Committee offered the possibility of three rate cuts next year, driving stock market indexes to new highs.
• The Fed's outlook has pivoted towards market expectations, with a median range of 4.50% to 4.75% interest rates predicted for next year.
• The biotechnology industry is favorably positioned in the current risk-on environment and has surged 25% since our last article on biotechs.

When Doves Fly

The last meeting of the year for the Federal Reserve's Open Market Committee was a magical act where it did not take away the possibility of a future rate hike if data warrants, but at the same time offered the financial markets a tantalizing prospect of three rate cuts next year.

The Fed's significantly dovish outlook drove the major stock market indexes (SP500) (NDX) to new highs for the year and the Dow Jones Industrial Average (DJI) to a new all-time high. The Fed's outlook is now beginning a shift towards market expectations.

Through the Summary of Economic Projections, the Fed governors are penciling in a median range of 4.50% to 4.75% by the end of next year, a sharp decline from their September estimate of 5.00% to 5.25%. The new range is the equivalent of three quarter-point cuts from the present range of 5.25% to 5.50%.

The Fed's pivot has been swift. Just two weeks ago at a fireside chat at Spelman College, in Atlanta, Chair Powell had indicated that it remains too soon to speculate when lower rates might be appropriate. The Fed's new outlook has stoked investor expectations for even deeper cuts with a majority of expectation on the CME Group's FedWatch tool, which evaluates the interest-rate futures markets, immediately shifting to a more aggressive 3.75% to 4% interest rate at the end of 2024. That is an expectation of seven quarter-point rate cuts.

And the Bulls Run

The Fed's sunny outlook has sealed a year-end seasonal rally, and the only question is how much higher the indexes will climb. The 10-year yield has plunged from 5% to nearly 4% in about seven weeks. That is fuel for the stock market, particularly after the Fed has stepped out of the way for now.

However, next year also brings the challenge of a slowing economy and pressure on earnings growth. Thus, stocks have room to run for now, particularly neglected growth stocks, but will face resistance from an uphill earnings climb in the first quarter.

In our opinion, one of the attractive industry groups in the present risk-on environment is biotechnology (IBB) (XBI). Recently, we published an article on Biotech Stocks Ready to Roar outlining why the industry is favorably positioned in a lower 10-year yield environment at a time when it remained one of the rare groups that were still trading at the pandemic level valuations of March 2020. Since then, the industry group has surged 25%.

Biotechs also have limited earnings risk and thus perform relatively well in a slow growth environment when stocks are more exposed to such risk. We have remained fully invested in the Prudent Biotech model portfolio, where Vertex Pharmaceuticals ( VRTX ) has remained one of the oldest positions. Biotech exposure also exists in the Prudent Healthcare and Prudent Small Cap portfolios.

The typical December rally has finally come true this year. The Fed released the doves this December, and the bulls are now in charge .

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