The Last Cut is the Deepest

The end of the Fed's rate-cutting cycle may be tomorrow.

The widely anticipated cut, the primary catalyst behind the market's recent rise, is unlikely to spur stocks higher. But it will be a necessary precondition for the acceleration of the economy that many, including myself, see in the year ahead. You may be asking, "What acceleration?" Isn't the anecdotal 'whisper' data on U.S. employment weak? Perhaps, but that stale data set will be in the rear-view mirror shortly once the calendar turns.

The seasonality of the markets stems from a multitude of factors, such as tax strategies, pension funding, positioning, and investor confidence. All of these look to be trending in the 'risk on' direction over the next critical months as we enter a new year.

After an initial bout of profit-taking in early January, investors tend to extend their "duration of confidence" in the first quarter of the year. Absent a harsh monetary backdrop, this pattern is a highly predictable feature of the equity markets. All that is needed is a few catalysts, and we get a flood of 'hockey stick' forecasts from analysts eager to predict an ever rosier future.

The early part of 2026 looks to be catalyst-rich.

1) Tax policies put in place both on investment allowances and personal rebates look to be encouraging corporate capex and a recovery in depressed consumer confidence - a Big Beautiful Visa Bill?

2) Tariff policies are being reversed or offset (farmers getting bailed out) due to pressures on affordability and, in the case of Nvidia chip sales to China, geopolitical realities. Could a renewed CUSMA deal be a spur to growth, as Trump's corporate backers pull him off the Navarro/Miller ledge? Remember, his nickname is TACO. Buy $CADUSD.

3) Lagged effects of lower short-term interest rates on lending from profit-rich banks will continue to reverse the credit standard tightening that tariffs wrought. Housing affordability remains an issue, but a mild cyclical recovery is likely as after-tax wage growth recovers. Buy TOL.

4) Continued wealth effect support from the soaring market will support high-end consumption, and some trickle-down can be expected. The 'trade up' stocks have been leading, but laggards like DLTR and DG are now bottoming nicely.

5) The self-sustaining bull market should show signs of broadening out. The Hyperscalers will lag as the AI focus will shift the efficiency gains to the user base - buy WMT.

6) The turning of the calendar page will reverse the window dressing and tax loss selling that has prevented the participation of lagging stocks, especially the cheaper smaller ones - buy IWM.

The post-Fed rate-hike weakness lingering from the 2022 tightness has run its course, and the gradual-easing effect is now set to kick in, as it did after the Covid-era Fed rate cuts.

Small Cap Relative Performance

None of these is a ' lock' as the gamblers say. But year-end is usually a time to lean into the consensus. And the consensus has continued economic weakness leading to at least two more rate cuts priced in for next year. That's not what I see. If any three of the above catalysts hold, the Fed will pause further policy accommodation. Inflation remains above target, despite the slowdown from tariffs. The unemployment rate should stabilize next year, with current weakness offset by further declines in participation rates and immigration. That will give the Fed cover to pause, and the market to change leadership from growth to value and small-cap factors.

My nervousness expressed last week about the change in the Fed chairmanship and the resulting politicization is a story for down the road. The rotating changes in voting members is also slanted towards the more hawkish views -Alberto Musalem (St. Louis Fed) and Jeffrey Schmid (Kansas City Fed). But it is interesting to watch the Treasury yield curve ''flex' here - short rates down and long rates up this week. This is usually behaviour seen at policy inflection points.

I see one here.

Risk Model: 3/5 - Risk On

People are starting to regain their confidence after the seismic Trump tariff/Doge shocks earlier this year. The chart below shows that, despite the raging bull market, investor confidence (AAII variety) has been muted. I know the meme stocks recovery and AI valuation surge show pockets of exuberance, but that confirms my view of an imminent rotation away from the tired leadership to a broader participation environment.

We may have finally reached the point where Trump is a spent force. By the time the Midterms arrive, he will be. People worried about the 'overvalued' stock market AI bubble, waiting for a black Swan. I'm seeing a potential for a 'Lame Duck' instead.