I think we're in for a rough end of the year: Sebastian

Key Concepts

• US Government Reopening: Significance for economic data availability and government spending's impact on the economy.
• Bifurcated Economic Situation: Divergence between strong stock market performance (especially big tech) and weakness in entry-level jobs and consumer spending for lower-income households.
• Bitcoin as a Risk Appetite Indicator: Bitcoin's correlation with riskier assets like the NASDAQ 100 and its role in signaling market sentiment.
• Federal Reserve Interest Rate Policy: The potential impact of a December rate cut on market rallies and the year-end performance.

The Significance of the US Government Reopening

Mark Sebastian highlights the reopening of the US government as a significant event for several reasons. Firstly, it allows for the release of crucial economic data that has been absent for two months. The only substantial data available has been CPI, with the ADP report being the closest to a jobs report, and it has been mixed. This lack of labor statistics has created "real economic uncertainty." The reopening provides an opportunity to assess the labor market and understand the extent to which the US economy is softening.

Secondly, Sebastian emphasizes the sheer scale of US government spending. He states that the US government is the "single largest buyer of everything in the United States," surpassing even the MAG 7 companies in economic influence. When the government is "borderline inactive," it has a "palpable effect on the economy." The positive reaction of US markets on Monday to the news of the government reopening underscores this point.

A Bifurcated Economic Landscape

Sebastian describes a "bifurcated economic situation" in the US. On one hand, the stock market is performing exceptionally well, with "big tech doing really well." This benefits the wealthier portion of the population, whose 401(k)s and IRAs are "looking pretty healthy."

On the other hand, there is a slowdown in hiring in areas where the US government typically provides resources, particularly at the entry-level. This makes it "real tough to be an entry-level college grad or college grad right now." Concurrently, other sectors like truck driving remain weak.

For individuals living "paycheck to paycheck," a combination of factors has created a "pretty big veil of fear." These include tariffs, the absence of a stock market wealth effect, and the US government shutdown. Sebastian believes that the softening in this segment of the market is becoming evident, citing McDonald's reporting "foot traffic being down" and the poor earnings in the "fast casual and fast food" sector as indicators of the "bottom portion of the US buyers softening up."

Bitcoin as a Gauge of Investor Risk Appetite

Sebastian views Bitcoin as the "ultimate signal of whether the market has a risk appetite or doesn't." He clarifies that Bitcoin is not an uncorrelated asset like gold or bonds. Instead, it exhibits a strong correlation with the NASDAQ 100, especially during "boom and bust times."

The recent "softness in crypto" and its "failure to really get any legs back" suggest that "something else may be going on." This could be a combination of investors selling after seeing weakness and a "little belt tightening" due to fear surrounding the "Treasury market trade" that previously boosted Bitcoin.

When individuals have "fewer dollars to play with," crypto, which is popular among younger demographics, is likely to be one of the first areas where spending is reduced. Therefore, Sebastian considers Bitcoin an "excellent judge of whether you can believe market rallies or sell-offs." He advises that "if the market is up and Bitcoin is soft, don't trust the market." He notes that Bitcoin has replaced the Russell 2000 as a more effective indicator of market momentum.

The Federal Reserve and the Likelihood of a December Rate Cut

Regarding the possibility of a Federal Reserve rate cut in December, Sebastian expresses surprise at Fed Chair Powell's reluctance at the last announcement. He anticipates that upcoming CPI data and BLS data will be important.

However, Sebastian points to corporate America's actions, such as "layoffs" by companies like UPS and Amazon, as evidence that "companies are tightening belts." This suggests that "we may need a little bit of a... some looser rates."

He believes the market has not mispriced the odds of a December rate cut, and an increase in these odds "could give some life to the market" and potentially lead to a "Santa Claus rally."

Conversely, if the Fed decides to hold rates, Sebastian predicts that "December is going to be a rough month for markets." He argues that the market's reaction to the potential certainty of a rate cut diminishing indicates that removing the possibility of a cut entirely would lead to a "rough end of the year." He concludes that if a rate cut occurs, "Santa Claus rally is on and we might even run to 7,000."