Decoding Markets: Filling the Blank Space

Estimated reading time: 6 minutes

Blank Space

Aristotle famously said that “nature abhors a vacuum.” In lay terms, the Greek philosopher was saying that any empty space is instantly filled by denser surrounding matter. The idea being that voids are effectively nothingness, and nothingness can’t exist. 

Pop singer Taylor Swift, a modern-era philosopher perhaps, sort of gets at the same idea in her song “Blank Space.” I.e. You don’t just let a blank space sit there — you fill it in!

And that’s what Wall Street did. When the government shutdown created a vacuum without hard economic data, investors looked at that blank space and wrote: Unstoppable AI Bull Market. 

In other words, without the reality check of inflation reports or jobs data to ground valuations, the market’s imagination was left to run wild. Tech company after tech company announced creative deals to invest in the artificial intelligence ecosystem, exciting some with the promises of a future utopia while worrying others that we might be in for a repeat of the vendor financing fallout seen in the dot-com bubble era.

Under Pressure

Since mid-May, the narrative was comfortable: Treasury yields were falling, stocks were rising. It was a textbook inverse relationship. But as you can see in the chart below, that relationship hit a sour note in October.

Stocks and Yields

After months of a smooth ride, the Federal Reserve’s mini- hawkish pivot finally injected some turbulence into the stock market. Fed Chair Jerome Powell explicitly warned that a December rate cut was not a foregone conclusion after the Fed’s Oct. 29 meeting, and since then, stocks and bonds have sold off. A 60/40 investor’s worst nightmare. 

This raises a logical question, though: Shouldn’t higher yields signal a stronger economy, which is good for corporate earnings?

Theoretically, yes. If rates are rising because the economy is robust, that should reflect in higher corporate profits. But the market is stumbling, which suggests that the recent rally wasn’t driven entirely by earnings growth, but also by speculation, liquidity, and sentiment. 

The numbers support the story. Though the S&P 500’s forward 12-month earnings per share (EPS) rose from $298 the day of the Fed meeting to $302 as of Nov. 19, the index’s forward P/E fell from 23.1x to 21.9x. That means that earnings’ contribution to year-to-date price returns rose from 8.1% to 9.6%, while valuation’s contribution fell from 7.7% to 2.0%. 

The current choppiness is a sign that investors realize the Fed may not ease monetary policy as fast as they had initially anticipated.

S&P 500 Year-to-Date Price Return

Stuck in the Middle With You

Now that the shutdown is over, the Fed has to navigate the incoming flood of economic data right alongside investors. There are 12 voting members on its rate-setting committee, so at least seven people have to agree on lowering rates. And unlike in the recent past, the central bank is currently a house divided. 

As the chart below illustrates, we currently have an even split:

• 4 Doves (favor lowering rates – aka easing)
• 4 Hawks (favor holding rates)
• 4 Neutrals (the swing votes)

(Though a tie has never occurred, it’s thought that a tie would result in the policy remaining unchanged.)  

Where 2025 FOMC Voters Likely Stand

The neutral group, which includes Powell and Vice Chair Jefferson, effectively holds the keys to the December meeting. If the backlog of data that’s starting to come out shows that the labor market did not deteriorate more during the shutdown, the neutral block will likely slide toward the hawks (and vice versa).

The Sound of Silence

Here is where the calendar works against us. Typically, the Fed likes to signal their intentions leading up to a meeting to ensure the market isn’t surprised by its eventual decision. However, their communications blackout period begins Nov. 29, which is right after Thanksgiving. 

Because the data (which is already stale in some ways) is arriving on such a lag, in addition to the November jobs and inflation reports being delayed, there’s a good chance that Fed officials won’t have clearly signaled what they plan to do at their meeting. 

That means investors should expect some noise and volatility over the next few weeks as Fed officials dance with the data. 

And when they go into their blackout period, perhaps markets will fill in the blank space again. Maybe it’ll be AI again, or maybe it’ll be something else. Your goal is to ensure your portfolio is resilient enough to handle whatever writes its name there next.

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