Feb 14 Strategic View
Investors are divided between hopes for a soft landing and concerns that aggressive rate rises may tip the US economy into a recession. There have been two different market performance regimes in 2023, with a positive outlook reflected in asset prices until strong employment data was released on February 3, causing concerns about rising inflation and potential rate hikes, leading to a decline in global stocks and increased volatility. The uncertainty in inflation, monetary policy, and growth inflection points has contributed to investors' expectations of continued volatility.
The downward trajectory for inflation is becoming less clear following recent data revisions, with US monthly consumer prices climbing in December rather than falling, as was initially reported. Even small moves in the wrong direction could potentially add to worries about how far the Fed will need to go to bring down inflation. Furthermore, employment data continue to send mixed messages. For example, the New York Fed's survey of consumer expectations revealed the largest drop on record in expectations for household income, which might kindle hopes that salary demands will moderate, a crucial factor given the Fed's focus on slowing wage growth. However, this contrasts with December's payroll data, which indicated that the US added 517,000 net new jobs in January, with unemployment falling to the lowest level since 1969.
Technical support for a smooth rise in markets has faded, and the speed of the rally at the beginning of the year was partly due to a shift in investor positioning, with hedge funds covering shorts and adding new longs. Now that investor positioning is more balanced, markets are more likely to be impacted by any bad economic news.
As long as there is no clarity in the economic outlook, near-term headwinds for markets will continue, with the potential for episodes of high volatility. Against this backdrop, it is recommended to adopt strategies that provide exposure to equity market upside while adding downside protection. Defensive (consumer staples and healthcare), value, and income opportunities should be considered as they could outperform in a high-inflation, slowing-growth environment, alongside select cyclicals that should perform well when markets start to anticipate inflections.