The stock market faces a paradox heading into 2024.

It has to do with two very different narratives about the state of our economy.

Investors are trying to have the best of both worlds, taking the good from each one while ignoring the inherent contradiction.

This is sending stocks higher for now. But these two competing narratives can’t coexist for much longer.

And when the truth about our economy unfolds, investors will finally have to reckon with reality.

So today I want to make sure you’re aware of what’s going on heading into the end of the year and 2024.

Inflation Still Drives the Market

Before I weigh in on the conflicting narratives on our economy, let’s first address what’s driving the market right now: inflation.

More specifically, we’re looking at how soon we can get inflation below the Fed’s 2% target, which could trigger a policy pivot.

The good news is we are making slow progress here. And that’s typically how inflation works; it tends to rise sharply and then fall much slower.

Yesterday, we got the personal consumption expenditures (PCE) report, which is the Fed’s preferred inflation measure.

The results of this report were in line with expectations. Cutting out food and energy, the PCE was up 0.2% month-over-month.

Over the last year, it was up 3.5%. This is higher than we want to see in the long term, but this number is also moving in the right direction.

So by this measure, it seems like the Fed has successfully gotten inflation under control. But there is more to this story…

Lower energy prices, both for crude oil and gasoline, have helped to ease inflation lately.

Yes, the Fed looks at core prices for inflation, which excludes things like food and energy in favor of identifying long-term trends.

But energy prices tend to feed through to that core number anyway. After all, it takes energy to get goods manufactured and transported from the warehouse to stores.

So low oil and gas prices will always reduce inflation, even if you try to take energy prices out of the equation.

That brings us up to speed on where we’re at now. Inflation is slowly coming down, but that could be subject to change if energy prices suddenly rise.

In other words, we’re likely at the end of a rate hike cycle. But there are differing opinions on when we could start to see rate cuts.

And herein lies the competing narratives on our economy…

Two Things That Can’t Both Be True

Looking ahead to next year, the markets are pricing in between four to five interest rate cuts in 2024.

This week the famous investor Bill Ackman said he expects the first rate cut as early as the first quarter of next year, which has some investors worried.

Bond markets, which look ahead to anticipated rate changes, are starting to reflect the likelihood of rate cuts next year as well.

And this ties back to similar sentiments from Jamie Dimon, CEO of JPMorgan Chase, who has been sounding the alarm on a slowing economy and rate cuts.

Falling interest rates typically act as a tailwind for stocks. So the anticipation of rate cuts has pushed stocks higher over the past month.

But there’s another competing narrative that’s also sending the broad market higher.

Many investors are still optimistic about the state of our economy heading into next year. Of course, there’s never a consensus on these things.

But generally speaking, analysts expect companies in the S&P 500 to grow their sales and profits for the next several quarters, which naturally helps boost stock prices.

Now take a moment to think about how these two things can both be true...

On one hand, companies are expected to grow profits next year.

But on the other hand, we also expect the Fed to cut interest rates next year, which typically only happens when the economy weakens.

Does that make sense to you? Well, it shouldn’t.

Both of these narratives are sending the market higher. But they present two opposing views that can’t be true at the same time.

So we have to think critically here… Is the economy strong? If so, we can’t reasonably expect five interest rate cuts next year.

Or is the economy weakening? If that’s the case, we probably can’t expect higher earnings from companies in the S&P 500 next year.

I’ve said this before, but I don’t necessarily trust the stock market right now. There’s still a lot of uncertainty, even if stocks are trading higher for the time being.

As investors, we have to focus on what is happening, not what should be happening. That’s why it’s so important to keep a balanced approach with your investments.

Looking at seasonality, the stock market tends to do well heading into the holiday season. So I’m not going to bet against that trend.

But I am watching carefully and keeping extra cash on hand to roll out bearish trades as soon as the tide begins to shift.