Weekly market insights

Machine Learning Intelligence

发布日期: 2023年8月28日

Institutional Opinions:

class="font-[700]">Federal Reserve Policy and Interest Rates: The Federal Reserve is adopting a more balanced approach to its rate hikes, suggesting that policy rates might be approaching a peak. The Fed is resolute in combating inflation and is likely to maintain high interest rates until inflation aligns with the 2% target. While the Fed could continue raising rates if necessary, it's becoming more cautious about potential over-tightening, given the ongoing economic resilience.

Despite initial expectations, economic growth has proven more robust, consistently surpassing forecasts. However, risks to growth persist—credit conditions are tightening, job gains are slowing, and the impact of prior rate hikes is still rippling through the economy. Positive economic momentum is expected to continue, with growth estimates being revised upward. The Atlanta Fed's real-time GDP forecast indicates strong growth.

Headline inflation has significantly decreased from its peak, and various categories are experiencing slower price increases. Core inflation remains elevated, motivating the Fed to work toward its 2% target, possibly maintaining a somewhat hawkish stance. Achieving the final stretch of the 2% target ("last mile" of inflation) could be challenging and might necessitate further adjustments in the labor market.

Financial markets are increasingly confident in the Fed's ability to achieve a "soft landing," with stocks displaying resilience and a likelihood of sustained positive trends. Bonds are facing pressure due to rising yields, though the higher-interest-rate element could mitigate price declines. Equity market valuations may not expand significantly without a potential Fed shift to rate cuts, implying slower gains. Historical patterns suggest heightened volatility in September and October, followed by equity rebounds, underscoring the importance of patience and investment discipline.

Investors are advised to consider a dollar-cost averaging strategy to capitalize on potential market volatility. Opportunities exist in undervalued segments of the equity market. In the fixed-income realm, positioning for potentially lower yields next year by balancing cash-like investments with longer-term bonds could be advantageous.

The recent rise in global long-term and real interest rates reflects the struggle of developed economies to finance post-pandemic deficit policies. In the U.S., concerns arise about the sustainability of increased government debt amidst monetary policies aimed at addressing an overheated labor market.

Both the market and BoA Global Research are growing more comfortable with the idea of a soft landing in 2024. Expectations include the peaking of short-term rates and anticipation of rate cuts by the Federal Reserve in 2024. Investors are encouraged to extend duration in Fixed Income portfolios due to attractive real and nominal rates during this phase of the interest rate cycle.

The housing market is experiencing a dearth of property turnover, with only 1% of U.S. homes changing ownership in the current year. This trend is driven by homeowners holding on to rock-bottom mortgage rates below current levels. Mortgage rates as low as 3% are attributed to pandemic-related distortions, with historical averages much higher.

August is expected to bring some softness, providing an opportunity for long-term growth investors to rebalance portfolios. The advice is to maintain a neutral stance across Equities and Fixed Income due to the mixed economic environment even in the soft landing scenario. Favoring high-quality companies with stable cash flows is recommended, particularly those poised to withstand prolonged slow growth.

The recent increase in real interest rates could be linked to the Federal Reserve's more lenient approach to inflation and the mounting interest expenses of government debt. There's potential for longer-term issues if rates remain elevated due to escalating deficits. The Fed's inclination to let inflation exceed its target implies the possibility of continued bear-steepening.

A sluggish housing market with minimal turnover is attributed to homeowners benefiting from mortgage rates significantly lower than prevailing levels. Low supply, rising prices, and increased financing costs have led to reduced housing affordability. Despite challenges, households possess substantial home equity, which could serve as support for future financial needs.

U.S. retirees are increasingly allocating a larger portion of their savings to equities, a trend seen over the past decade. More than 70% of portfolios for over-55 actively managed 401(k) investors are in stocks, compared to 38% in 2011. Similar patterns are observed among investors aged 65-69 and even those 85 or older.

The surge in equity allocation among retirees can be attributed to several factors. Historically, stocks have outperformed bonds in terms of returns, a trend that could continue, especially with elevated inflation post-pandemic. The tendency to "buy on dips" due to rapid equity market rebounds supports higher equity exposure.

The Federal Reserve's history of intervening during financial crises has instilled confidence in investors that markets will rebound, reinforcing their willingness to allocate more to stocks. The concept of a "Fed put" has evolved, with investors less concerned about market crashes and more confident in eventual recoveries.

The majority of retirees are from the baby boomer generation, which tends to exhibit greater risk tolerance due to not experiencing major financial downturns in their active investing years. Longer life expectancies also encourage greater equity exposure in retirement portfolios.

While higher equity exposure can lead to potential gains, it also comes with risks. Retirees might be forced to sell stocks at discounted prices during market downturns, impacting their retirement funds. Additionally, increasing healthcare costs and uncertainties around future fiscal spending policies could affect retirees' financial stability.

The trend of higher risk tolerance among retirees may lead to increased portfolio rebalancing during market volatility, aiming to buy stocks at more attractive prices. However, uncertainties around fiscal policies and the competition from higher bond yields could impact the effectiveness of the "buy on the dip" strategy. As a result, aligning asset allocation with risk tolerance and time horizon is advisable.

Equity markets, including the S&P 500, Equal-Weighted S&P 500, Nasdaq Composite, and Russell 2000, have experienced a pullback with negative returns since the beginning of August. This period aligns with historical seasonality trends, as August to October is historically a softer period for the markets.

The current moderation in market momentum is attributed to higher bond yields and oil prices. The US 10-year Treasury yield and 2-year yield have reached significant highs, impacting investor expectations. Rising WTI crude oil prices are also contributing to increased costs, potentially slowing economic growth.

Weaker economic activity in China and Europe is adding headwinds to market moderation. Economic indicators, particularly PMI services, are signaling contraction in these regions. The potential impact of tighter lending and high interest rates on consumers is a concern.

Earnings trends from Q2 retail earnings suggest a bend-but-not-break pattern in consumer spending and economic activity. Back-to-school spending provides hope for the latter half of 2023, but challenges like higher credit card delinquencies and inventory shrinkage are also observed.

The prevailing trend, prior to recent volatility, is expected to hold. The current pullback is seen as a healthy consolidation, allowing fundamentals to catch up with price. Key support levels for the S&P 500 are identified around 4200-4328, reflecting a typical drawdown from peak levels.

The Equal-Weighted S&P 500 and Small Caps are testing potential support at their 200-day moving averages. The short-term movement and oversold relief rally at these levels will provide insights into future trends. Increasing participation beyond the Tech sector is crucial for a healthy bull market.

The increase in US Treasury yields and WTI crude oil prices is impacting economic growth and investor sentiment. Higher interest rates and energy costs act as headwinds to the bullish, soft-landing narrative. Monitoring the interactions between oil prices, interest rates, inflation, and Fed policy is essential for short-term market movements.

Upcoming data releases, including AI-related semiconductor earnings and Fed comments at the Jackson Hole Economic Symposium, will shape economic expectations and market trends. Employment figures, such as JOLTS Job Openings and the August Jobs report, will also play a significant role.

The effects of rapid central bank tightening are anticipated to have a lagged impact on the economy, potentially acting as a drag on economic outlook. While excess savings and fiscal stimulus have supported growth, concerns about central bank actions influencing economic trends remain.

Given the complexities of market dynamics, potential economic volatility, and the possibility of earnings estimates being too high, investors are advised to continue monitoring data and trends. The current situation calls for caution, adaptive strategies, and an awareness of potential drawdowns and market waves.

The U.S. stock market ended the week with mixed returns due to investors reacting to conflicting signals about the economy and monetary policy. Growth stocks outperformed value shares, with a strong performance from AI chipmaker NVIDIA. However, the downgrade of credit ratings for regional banks and cautious reports from several retailers contributed to the mixed sentiment.

The Q2 earnings reports from retailers like Macy's and Nordstrom pointed towards growing consumer caution. Macy's reported falling earnings and warned of consumer caution and rising credit card delinquencies. Nordstrom, while beating earnings estimates, expressed concerns about late payments on its credit cards. Other retailers like Dollar Tree and Dick's Sporting Goods noted earnings impact due to store theft.

The University of Michigan's consumer sentiment index for August indicated a slight dip from July's high, potentially due to increased inflation expectations. However, strong income expectations and low jobless claims suggest ongoing labor market health, although wage growth might have slowed due to higher rates.

Durable goods orders data hinted at business caution, with fluctuations in orders indicating mixed economic conditions. Manufacturing activity, as indicated by PMI, contracted slightly, affecting business investment outlook. The housing sector, however, appeared resilient, with new home sales reaching a high despite high mortgage rates.

Federal Reserve Chair Jerome Powell's speech at the Jackson Hole Economic Symposium provided insights into his interpretation of mixed signals. He noted that higher rates impacted industrial production and wages, while the housing sector was showing signs of recovery. The economy's trajectory appeared uncertain due to various factors.

Both stock benchmarks and bond yields experienced fluctuations post-Powell's speech. The 10-year U.S. Treasury yield initially reached 15-year highs but retreated slightly by the end of the week. The bond market exhibited mixed performance, with investment-grade corporate bonds and high yield markets seeing limited activity.

European markets ended the week with gains, as declining natural gas prices and prospects of peak interest rates contributed to positive sentiment. However, weaker economic data prompted markets to lower expectations for future interest rate increases.

Eurozone business activity indicated a contraction for a third consecutive month, suggesting economic challenges. The German economy was predicted to stagnate in Q3 due to weak foreign demand impacting industrial production. Business confidence in Germany also declined.

UK business activity contracted, indicating potential economic challenges. In Japan, equities rallied initially due to positive data announcements but faltered towards the end of the week due to concerns about China's slowdown and trade relations. The yen continued to weaken against the U.S. dollar.

Chinese stocks declined as negative economic data and deflation signs raised concerns about the country's economic outlook. Erosion of confidence in China's economy led to capital outflows and worries about accelerated outflows. China's government proposed measures to support the property sector and mitigate challenges in the property and trust sectors.

Turkey's central bank announced measures to address unsustainable accumulation of FX-protected deposits. These measures aim to reduce costs associated with FX fluctuations and could lead to increased regulation and a shift in deposit behavior.

Brazil's lower chamber voted in favor of new fiscal rules to manage government spending and debt growth. These rules aim to limit spending growth in relation to revenue increases and inflation, with potential implications for Brazil's fiscal management.

Despite initial forecasts of a recession, recent data indicates a reacceleration of economic growth. The Atlanta Fed's GDPNow model estimates a 5.8% annualized growth rate for the current quarter. This would mark the fifth consecutive quarter of growth at or above trend, highlighting the economy's resiliency even with tighter monetary policy.

Retail sales exceeded expectations, with a 0.7% month-over-month (m/m) gain and a 1.0% increase excluding autos. Online sales contributed significantly to the increase. Industrial production also showed strength, rising by 1.0% m/m due to robust auto production and high demand for cooling amid sweltering temperatures.

The housing market displayed signs of stabilization as housing starts and permits increased by 3.9% and 0.1%, respectively. Single-family gains outweighed multi-family declines in both measures.

While the 5.8% growth estimate is strong, it's not guaranteed. Historical data shows that the GDPNow model has, on average, overestimated the final GDP print by 0.8% at this point in previous quarters, and by 2.2% when the model was above 4%. This suggests that caution should be exercised regarding the accuracy of the growth estimate.

Strong economic momentum indicates a likelihood of avoiding a recession in 2023. This momentum has contributed to higher yields. However, risks remain for 2024. The sustainability of robust growth will be key in determining whether yields have reached their peak. With the 10-year yield at 15-year highs, investors might consider adding duration to their portfolios to benefit from attractive income and prepare for eventual lower yields.

Equities are currently oversold and experiencing a short-term rebound, which is supported by the recent pullback in interest rates. The focus remains on rising interest rates, with the US 10-year yield testing a critical technical range of 4.24-4.33%. The pullback to 4.20% is seen as a positive development for the ongoing short-term equity market rebound. Investors are closely monitoring the technical levels for the US 10-year yield between 4.33% on the upside and 4.0% on the downside, with anticipation of Jerome Powell's comments at the Jackson Hole Economic Symposium as a directional catalyst.

The expectation is for interest rates to stall around current levels, despite the consensus and hedge fund positioning that suggest higher rates. The key downside level is projected to be between 4.0-4.09%. However, the possibility of a breakout above 4.33% is highlighted as a significant technical event that could lead to further upside, potentially reaching 5%. Such a move would pose challenges for equities, particularly growth stocks with higher multiples.

The equity markets are undergoing a short-term oversold rebound, with support near S&P 4300 and Nasdaq 13,150. While this bounce is taking place, Q3 is expected to remain volatile due to weak seasonality and the current technical backdrop of the S&P 500 and interest rates. Negative weekly momentum indicators signal the potential for choppy trading through Q3, even as the market attempts to rebound from support levels.

The performance of the SOX Semiconductor index will be crucial to monitor as key semiconductor companies report earnings. Short-term indicators for the SOX are oversold and starting to show signs of bottoming and turning up following a pullback to uptrend support around 3400. Resistance levels are identified at 3662 and a range between 3875-4068, near Q1 2022 highs. The 2023 uptrend lines are considered significant levels for managing downside risk.

While the possibility of a "soft landing" for the U.S. economy is conceivable, certain uncertainties still pose risks: Upside risks to inflation warrant monitoring, even though price pressures have subsided. Various measures of worker compensation growth appear higher than what's consistent with expectations of inflation returning to the Fed’s two percent target over the medium term. Core CPI (excluding food and energy) remained at 4.7 percent y/y in July. The delayed effects tied to monetary policy adjustments need consideration. The persistent economic strength might lead to the view that the U.S. economy is immune to higher interest rates. However, a more plausible explanation is the lag for monetary policy impacts to be felt. Each rate hike can deliver headwinds to economic activity lasting about 2.5 years. The potential for monetary policy to remain restrictive for an extended period or become even more so, coupled with onerous bank lending standards, could increase economic vulnerability to higher borrowing costs and impact corporate earnings.

Despite a steep rise in interest rates across many countries over the past year, global growth has maintained an upward trajectory. As the largest economy in the world, the U.S. continues to display resilience. Projections from the Federal Reserve Bank of Atlanta’s GDPNow model suggest U.S. real GDP could expand by over five percent in Q3. Should this forecast hold true, U.S. economic growth would more than double its Q2 rate, marking the fastest pace since Q4 2021. While we think this forecast will almost certainly be revised lower as the quarter progresses, the recent trend of economic data surprising on the upside paints a picture of an economy running stronger than expected. In our view, the following constructive factors that have been propelling the U.S. economy could help extend the growth runway in the near term: Disinflation is well underway, with the U.S. Consumer Price Index (CPI) falling to 3.3 percent in July from a peak of 9.1 percent year-over-year (y/y) in June 2022. This trend is expected to continue, driven by lower energy and goods prices, along with anticipated easing of shelter inflation. U.S. households remain in good shape, with deployable savings and strong labor demand continuing to boost income gains. Despite a slowdown in hiring pace, the low unemployment rate, ample job openings, and positive inflation-adjusted pay increases indicate a favorable environment. Corporate fundamentals show resilience. The Q2 earnings season featured above-average beat rates relative to consensus profit estimates, solid margins, and stable guidance. These trends reflect companies' ability to manage operating costs and defend margins without resorting to widespread layoffs.

Global equities have yielded strong returns this year, boosted by robust U.S. data that dispelled concerns of a significant growth slowdown in 2023. Lower inflation and sustained labor market strength have driven markets to embrace the likelihood of a benign "soft landing" as the most probable outcome for the economy in the coming quarters. This optimistic economic view has translated into the stock market through valuation multiples rebounding and earnings estimates stabilizing. In the fixed income markets, reduced compensation for credit risk is reflected in narrower credit spreads. Although higher base interest rates persist, they help maintain attractive all-in yields. In summary, a moderately defensive stance in portfolios, emphasizing relative value, remains prudent given the U.S. economy's positioning in the later stages of the business cycle.

Rising prices of 10-year U.S. government bonds this week briefly pushed yields to their highest level since 2007. This move followed stronger-than-expected economic reports, comments from Federal Reserve speakers on higher interest rates to combat inflation, and increased bond auction sizes. The resulting yield increase was likely amplified by thin August trading conditions. Recent data indicating slowing manufacturing activity and weaker-than-expected growth in services have eased selling pressure on bonds. The upcoming speech by Fed Chair Jerome Powell at the Jackson Hole monetary policy conference is anticipated to attract investor interest. This year's symposium, focused on "Structural Shifts in the Global Economy," may provide insights into short-term policy decisions, although Powell might emphasize the Fed's data-dependency and commitment to price stability. Interest rate futures pricing reflects relatively low odds of significant future Fed rate hikes, with around a 50% chance of an additional hike in this cycle, based on recent closing levels. Changes in prices have highlighted shifts in when and how quickly the central bank will look to reduce restrictive policy. The potential for delayed rate cuts, rather than further hikes, is now more prominent. The possibility of rates above 5% through at least June 2024 and an expected year-end 2024 level closer to 4.2% has gained traction.

Global crude oil prices have rallied, rising approximately 18% above year-to-date lows. This increase coincides with higher global refinery runs and an incremental 2.2 million barrels per day increase in economic activity compared to the previous year. Despite this, major regions such as the U.S., Europe, and China have not experienced inventory builds, indicating a supply-demand mismatch. Refined product demand is expected to remain healthy, keeping the physical market tight. As a result, WTI prices are anticipated to trade around US$80 per barrel unless new catalysts emerge. This positive backdrop supports energy producers in generating cash flow, reducing debt, and returning capital to shareholders. The Canadian economy remains robust, with resilient household consumption trends and improved housing activity, despite the impact of higher borrowing rates. However, concerns persist over the leveraged position of Canadian households, particularly if labor market weakness materializes, making household debt harder to service and potentially affecting economic activity.

Economic activity in the eurozone has declined, with the preliminary Eurozone Purchasing Managers’ Index (PMI) falling to 47 in August from 48.6 in July. This reading, significantly below expectations, indicates contraction. The services sector, which had previously been in the expansion zone, also experienced a meaningful decline into contraction territory. The weaker-than-expected data increases the likelihood of a European Central Bank (ECB) pause in its upcoming September meeting. However, rising input cost inflation due to wage pressures is a concern that could prompt further tightening, potentially beyond the current 3.75% level. Rising 10-year nominal Bund yields driven by inflation expectations raise concerns at the ECB. The UK's preliminary composite S&P Global/CIPS PMI also fell into contraction territory, declining to 47.9 from 50.8 in July. This reading, the lowest since the beginning of 2021, reflects challenges similar to those in Europe. Market expectations of the terminal Bank Rate have fallen, reflecting uncertainties about economic outlook.

U.S. Secretary of Commerce Gina Raimondo's visit to China for meetings with senior Chinese officials and American business leaders indicates efforts to address issues through dialogue. This may pave the way for a potential meeting between U.S. President Joe Biden and Chinese President Xi Jinping at the Asia-Pacific Economic Cooperation meeting in November. China's decision to suspend seafood imports from Japan due to concerns about nuclear-contaminated wastewater will likely impact Japan's fishing industry. Baidu's strong Q2 earnings and investment in AI bode well for its future, with the launch of the Ernie 3.5 generative AI large language model contributing to its positive outlook.

Previous update:

Institutional Opinions:

Market Outlook for the Rest of the Year: The recent weakening of the market in August, following a significant rally from March to July, is seen as a normal and healthy pullback. This downturn doesn't necessarily indicate a pessimistic sentiment, but rather a recalibration in response to the rapid gains. Despite expectations of a slowdown in the economy, there is no indication of an impending severe downturn. Instead, the prevailing belief is that if the economy manages to avoid a substantial recession and maintains its robust employment conditions and consumer financial stability, the gains made since the bear market low of the previous year are not likely to be significantly reversed. As the year progresses, changes in economic expectations are expected to play a pivotal role in influencing market movements.
Small-Cap Stocks and Economic Expectations: The recent retreat in small-cap stocks is interpreted as a necessary adjustment towards more realistic economic forecasts, rather than a signal of imminent economic collapse. The notion of a "rolling recession" emerges, suggesting that different sectors of the economy may undergo periods of deceleration at different times, leading to a moderate overall decline in GDP growth. While consumer spending is projected to slow, it's anticipated that consumers won't completely halt their expenditures. The shift in spending habits, with an emphasis on services and leisure activities, is supported by recent data.
Interest Rates and Fed Policy: The recent surge in interest rates is attributed to a shift in consensus expectations surrounding Federal Reserve (Fed) policy. The notion is that the Fed will opt for an extended period of higher policy rates, influenced by the persistent strength of economic growth. The increase in long-term rates is seen as a reflection of this heightened economic vitality rather than a precursor to immediate rate hikes by the Fed. The expectation is that inflation will continue to stabilize, implying that the Fed will not need to rapidly tighten its policies. This points to the concept of "higher for longer" rates, rather than a sudden and drastic escalation.
Tech and Growth Stocks: The current retreat observed in technology and growth stocks during August is interpreted as a necessary correction, aimed at reducing the excessive enthusiasm and valuations that had accumulated in these sectors. Rather than implying a fundamental breakdown, this pullback is viewed as a precautionary step in the wake of an impressive rally. Notably, while these sectors experienced a dip in stock prices, their earnings held up relatively well, indicating that the correction might be more influenced by valuation concerns and the impact of rising interest rates than by a broad decline in market fundamentals.
Market Volatility: Anticipations point to increased market volatility in the upcoming months compared to the previous period, implying that fluctuations in the market are likely to become more pronounced. Market participants should consider using a correction in stock prices as an opportunity to rebalance portfolios, taking advantage of what is seen as a more sustainable bull market trajectory over the longer term.?
U.S. Corporate Earnings and Profit Margins: U.S. corporate earnings have exhibited a year-long stagnation, but Q2 results managed to surpass low expectations, primarily due to improved profit margins. The outlook for expanding profit margins into the next year appears optimistic, although caution is advised as the author advocates a selective approach in equities. The possibility of a margin squeeze looms due to worker shortages pushing wages upward, challenging the sustained growth in profit margins despite the favorable consensus view.
Inflation and Labor Market Dynamics: The data underscores the continuation of inflation volatility, shaped by evolving supply and demand dynamics. A pivotal observation is that a structural labor shock is taking precedence as an inflation driver. The pandemic-induced shifts in spending and labor market disparities are unwinding, leading to a new phase of inflation. The aging population adds another layer of complexity, potentially intensifying labor shortages and fueling wage pressures. This scenario might contribute to sporadic inflation spikes as labor market dynamics change.
Market Volatility and Central Bank Policy: The market's recent behavior, marked by U.S. stock stability and surging 10-year Treasury yields amid volatile trading, indicates ongoing market volatility. The shifting dynamic is influenced by economic data, such as CPI reports. The perception that central banks will not hastily ease policies in the face of supply constraints emerges. Rather, central banks are expected to adopt tighter policies to counter inflationary pressures, signaling a departure from the era of steady growth and inflation known as the Great Moderation.
Investment Themes and Strategies: The evolving market volatility brings forth a trend of divergent security performance, prompting a more detailed and selective investment approach. As markets become more volatile, the data suggests that deviations from index performance will become more significant, providing opportunities for targeted investments. A focus on security selection, expertise, and skill is seen as crucial for achieving above-benchmark returns. The investment themes highlight the importance of identifying mega forces, such as AI and geopolitical shifts, and harnessing their potential for gains.
Inflation Trends and Aging Population Effects: The data illustrates recent core inflation trends that point to progress in managing inflation issues. Notably, goods prices are contributing to a decline in inflation as demand normalizes. However, a noteworthy shift is expected as the economy transitions from one shock (pandemic-related shifts) to another (effects of an aging population). This transition could lead to inflation experiencing a rollercoaster ride, as changes in labor dynamics and job growth interact with economic dynamics.
Macro Strategy—Market and Macro Themes to Consider: This analysis presents key macro and market themes driving recent investment performance and offers insights into their future outlook. The current global geoeconomic backdrop reinforces U.S. structural advantages, driving asset flows and relative equity outperformance. The U.S. enjoys secure food and energy supplies, a lead in high-growth and margin businesses, and maintains its world reserve currency status. As other engines of growth struggle, U.S. equities appear more attractive. The U.S. is witnessing an economy that prioritizes jobs even as profits decline. Nonfinancial corporate productivity contracted while corporate profits faced challenges. Consumer spending on services has remained strong due to labor hoarding, supporting overall growth despite sectoral challenges. New home construction trends have driven the performance of homebuilder stocks, while existing home sales faced weaknesses. The underbuilt housing market over the last decade has boosted new home builders and sales, influencing consumer discretionary stocks. Inflation has slowed since its peak, with the Federal Reserve tightening monetary policy. The end of rate hikes may be approaching as inflation moderates and economic growth potentially slows. Markets are also pricing in future Fed cuts. Despite an earnings recession in the S&P 500, results have generally exceeded fears. Small-cap earnings have been worse, but the overall outlook remains relatively flat for 2023. Expectations for strong earnings growth exist for the following year. Equity market gains have largely relied on valuation expansion, with specific stocks driving most of the index's gains. Broader equity action has shown resilience but also revealed emerging meme stocks, indicating mixed market dynamics.
Market View—The Rise of a "Mixed Economy": The shift towards a mixed economy, where government intervention is prominent alongside the private sector, has important implications for investors. The era of minimal government regulation is evolving, with increased state activism shaping markets and economies. Government as a catalyst for growth and innovation is explored, highlighting public investment's role in technological advancements.
Crosscurrents in Action—Navigating Uncertainties: The analysis observes conflicting signals in the global economy, akin to crosscurrents within a collision of oceans or macroeconomic regimes. Economic resilience and sentiment have supported risk assets, defying recession concerns. However, concerns about liquidity, tightening monetary policy, and global economic challenges pose potential headwinds for equity markets.
Investment Implications: Maintaining a balanced approach with a neutral weight to equities and a preference for high quality across asset classes is advised. The geoeconomic backdrop supporting U.S. structural advantages is expected to continue, favoring relative U.S. equity flows. Quality and large-cap stocks are favored due to their resilience in challenging environments. Investors should closely monitor housing sales, inflation trends, and earnings outlook. Reinvestment risk becomes prominent, suggesting a slightly long-duration position. While sentiment remains positive, potential liquidity challenges and global economic uncertainties underscore the need for a diversified, balanced portfolio.
Economic Resilience and Growth Slowdown: The data indicates that the economy showed remarkable resilience after the pandemic-induced shock in 2020. The support came from various factors, including economic stimulus, cash injections by the Federal Reserve, and pent-up consumer demand. However, the text suggests that these supports are expected to reverse in the balance of 2023 and into 2024. This implies that economic growth is likely to slow down, and corporate profits might decline, potentially leading to a more challenging economic environment.
Tightening Financial Conditions: The data suggests that financial conditions have already tightened due to factors like declines in the money supply, tightened credit standards by banks, and rising inflation-adjusted interest rates. This could lead to an accelerated rise in corporate bankruptcies and impact economic activity. This tightening could also have implications for equity markets and valuations.
Labor Market and Consumer Spending: The data indicates that while job gains and wage growth have been strong, they are beginning to soften around the edges as labor supply rebalances with demand. This trend is likely to continue, impacting consumer spending. Spending growth on services, which was initially strong due to pent-up demand, has begun to slow down. This could affect sectors like autos, travel, and entertainment.
Inflation and Monetary Policy: The data suggests that inflation's outlook has become uncertain, influenced by factors like energy, food, and shelter prices. Slower progress against inflation could delay improvements in real incomes and lead to more rate increases by the Federal Reserve. This indicates that inflation dynamics will be important to watch, as they can impact both economic growth and monetary policy decisions.
Equity Market Performance: The equity market has experienced a stall due to factors like rising long-term interest rates, concerns about a slowing economy, lingering inflation, and lackluster earnings. This could lead to downward pressure on equity valuations. The suggestion to stay defensively positioned in equities and to wait for a better risk-reward tradeoff indicates a cautious outlook for equity market performance.
Oil Prices and Supply: The data suggests that tight global oil supply has been a significant factor driving higher crude oil prices. As long as global supplies remain tight and demand holds up, the outlook for oil prices remains positive. The expectation of a U.S. recession in 2024 might impact oil prices, but tight global supply is expected to remain a driving force.
Hedge Fund Performance: Hedge funds, particularly long/short equity strategies, have shown varied performance. Lower-risk strategies achieved positive returns, while higher-risk ones experienced more significant declines but have rebounded. The preference for more defensive strategies that offer consistent results indicates a cautious approach to hedge fund investments.
Municipal Bonds and Fixed Income: The U.S. municipal bond market has seen positive performance, and this trend is expected to continue despite concerns over a potential recession. While municipal bonds appear somewhat expensive compared to historical averages, the technical imbalance between supply and demand continues to support municipal bond valuations. Municipal investors are advised to undertake meticulous credit research or access professional management.
Equity Market and Interest Rates: The recent rise in interest rates is a significant factor affecting the direction of equities. The US 10-year yield is challenging a key trading range at 4.24-4.33%. If rates break out above 4.33%, it could lead to further equity weakness, particularly impacting growth/technology stocks. Conversely, a move below 4.09% could signal a potential reversal in rates to the downside.
Equity Performance and Seasonality: The outlook for equity markets suggests a weak and choppy trading range into September. Weekly momentum indicators indicate overbought levels, and seasonality remains unfavorable through much of September. Key support levels are identified for the S&P and Nasdaq indices.
Short-Term Equity Momentum: Short-term momentum indicators indicate that the equity market is oversold, and an upward bounce is likely in the short term. However, further consolidation is expected into September. The S&P is testing a support band near the March uptrend and its rising 50-day moving average.
Oil and Exploration and Production Index: WTI Oil is viewed as being in a broad bottoming pattern after a correction in Q2 2023. A short-term pullback is underway, and support is expected in the 74-77 range. The S&P 500 Exploration and Production index is also pulling back from resistance, and there's an expected support band between 622 and 593.
Healthcare Sector as a Safe Haven: The S&P 500 Healthcare sector is considered a relative safe haven during the seasonal weakness of Q3. While other growth stocks have pulled back, the Healthcare sector is showing signs of improvement despite lagging the broader market.
Commercial Real Estate Challenges: The commercial real estate sector, especially downtown office space, is facing challenges due to remote work trends and elevated interest rates. Large office towers in central business districts are experiencing declining occupancy rates, leading to rental income reduction and refinancing difficulties. This trend is expected to continue, and the sector may witness further price declines in some commercial assets. Not all types of commercial real estate are affected equally. Industrial and warehouse properties are seeing high demand and stable to rising lease rates, while office space is impacted by remote work. Differences are also observed between regions and asset types. The challenges in the commercial real estate sector are unlikely to cause widespread economic fallout. The sector's scale, low direct exposure in investor portfolios, and manageable banking system exposure contribute to the broader economy's resilience.
US Economic Data: Economic data from the US suggests mixed sentiment. Despite negative news in the commercial real estate sector, strong July retail sales and industrial production growth indicate that tighter monetary policy is having limited impact on real economic activity.
UK Inflation and Monetary Policy: The UK is grappling with stronger-than-expected inflation, challenging the Bank of England's (BoE) efforts to meet its 2% inflation target. The BoE is likely to raise rates further to address inflation, and policymakers are focusing on labour market tightness, wage growth, and services inflation as determinants of future policy actions.
China's Property Market and Developers: China's property market is facing challenges, with slowing pre-sales and declining home prices. Large property developers like Country Garden Holdings are experiencing liquidity issues and potential defaults, adding pressure to the Chinese real estate sector and the broader economy.
China's Tourism Resumption: China's decision to lift bans on group tours to Japan, South Korea, the US, UK, and Australia is expected to have a positive impact on retail, cosmetics, and travel sectors in those countries. This resumption of group tours indicates the potential for increased Chinese travelers and benefits various industries in those regions.
Equity Market Pullback: The equity market is currently experiencing a minor pullback, with the S&P 500 down by 3.8%, the Nasdaq down by 6.1%, and the Russell 2000 down by 5.6%. This pullback is the most significant since the March banking crisis.
Technical Analysis and Support Levels: Technical analysis indicates that the S&P 500's price action has become heavier, and the index recently closed below its 50-day moving average for the first time since March. The market's recent strength and elevated valuations are making equities susceptible to a correction. Significant support levels for the S&P 500 are seen in the 4200-4328 range, reflecting a 6-8% drawdown from the peak. This level of drawdown is considered normal historically.
Market Sentiment and Momentum: Market sentiment appears to be moderating, with examples of failed rallies and a "buy on the rumor, sell on the news" trend. The current pullback is seen as a market normalization from overbought conditions, and a "buy the pullback" mentality is likely to emerge soon. While the market is near short-term oversold levels, it may still have further to go on the downside before the drawdown is over.
Seasonal Trends: The historical seasonal trend suggests that the period from August through October is the seasonally softest for the equity market. While it's not recommended to base investment decisions solely on the calendar, this historical pattern is worth considering.
Market Pricing and Valuation: The equity market appears to be pricing in a soft-landing economic scenario, with a focus on the rebound of economic leading indicators. However, the current high valuation multiples, such as a forward P/E multiple of 19x for the S&P 500, suggest that investors are expecting a rebound that might take time to materialize.
Inflation and Economic Trajectory: Core CPI has risen by 0.2% for the second consecutive month, moving towards the Fed's target range of 2-2.5% y/y. The trajectory of inflation is expected to be uneven due to factors like rising oil prices and elevated wages, which could impact both prices and corporate earnings.
Market Technical Indicators: Various technical indicators, such as the percentage of stocks above their moving averages, suggest that while the market may be near oversold levels in the short term, it's not yet at extreme oversold conditions that are typically associated with significant drawdown periods.
Market Path and Volatility: While a bounce is expected, the extent of the bounce and subsequent market behavior will provide insights into the path ahead. If the bounce is limited and equities break lower, the likelihood of further downside increases. However, barring a significant negative catalyst, the pullback is considered a market normalization within a larger uptrend.
U.S. Equity Market Movement: The U.S. equity market experienced a retreat for the third consecutive week due to several factors. The primary reasons include a sharp increase in longer-term bond yields and concerns about a slowdown in China. The S&P 500 Index ended the week down 5.15% from its recent peak on July 26. Growth stocks were impacted more than value stocks, while small-cap stocks performed the worst.
Economic Indicators and Consumer Spending: The release of July retail sales data showed a significant increase of 0.7% over the month, surpassing consensus estimates. This surge in sales indicates that consumers are continuing to spend, particularly in discretionary categories such as restaurants, bars, and online purchases. However, gas station sales saw a notable decline of 20.8%.
Economic Outlook and Industrial Production: Despite concerns, some economic data suggest the possibility of the economy avoiding a "soft landing" or "hard landing." Industrial production grew by 1.0% in July, much higher than consensus estimates, and a gauge of manufacturing activity in the mid-Atlantic region indicated expanding factory activity, orders, and shipments for the first time in 14 months. Housing starts also rose beyond expectations.
Federal Reserve and Rate Expectations: The release of the Federal Reserve's July policy meeting minutes raised worries about the central bank's response to continued economic growth. The minutes were interpreted as generally hawkish, even as Fed officials expressed hopes for gradual slowing in real GDP growth to address demand-supply imbalances.
Economic Growth Forecasts: Growth forecasts for the U.S. economy appear to be rising. The Atlanta Fed's GDPNow forecast for the current quarter jumped to 5.8%, well above the second-quarter growth rate of 2.4%. Economists in the "Blue Chip" survey are also revising their growth forecasts higher. Despite this, rate hike expectations as measured by the CME FedWatch tool remained relatively stable, suggesting that rates might stay at their current level through the end of the year.
Treasury Yields and Bonds: The positive economic surprises led to a rise in the benchmark 10-year U.S. Treasury yield to its highest level since at least October 2022. However, there were concerns about heavy issuance and supply, affecting bond markets. Investment-grade corporate bonds underperformed Treasuries, particularly in the auto sector.
European Markets: European stock markets experienced declines, primarily driven by concerns about China's economic outlook and higher European interest rates. Major indexes such as the STOXX Europe 600, CAC 40, DAX, FTSE MIB, and FTSE 100 all weakened.
UK Economic Indicators: In the UK, wage growth accelerated, increasing pressure on the Bank of England to raise interest rates further. While annual inflation slowed in July, core inflation remained strong. Signs of cooling in the labor market also emerged, with a higher unemployment rate.
Japan's Economic Performance: Japan's stock markets declined due to concerns about China's economic weakness. However, Japan's second-quarter GDP growth exceeded forecasts, driven by external demand. Consumer price inflation remained elevated, and the yen weakened against the U.S. dollar.
China's Economic Challenges: Chinese stocks faced declines amid pessimism about the country's economic recovery. Weak economic activity, including industrial output and retail sales growth, raised concerns. The property market downturn also continued, impacting China's economic outlook. The People's Bank of China unexpectedly cut rates, reflecting efforts to address weak demand.
Emerging Markets (Peru and Argentina): Peru's central bank kept its policy rate unchanged but signaled a potentially dovish stance in the future. Argentina allowed its currency to devalue against the U.S. dollar, along with a key interest rate hike, as the country faces inflation and financial challenges.
Market Concentration and Narrowness: The S&P 500's year-to-date gains have been highly concentrated, with the top 10 stocks accounting for a significant portion of the index's overall performance. As of the last market close, these top 10 stocks contributed to 90% of the index's year-to-date gains. However, the situation has improved compared to May, where the entire year-to-date gains were solely driven by the 10 largest stocks. This narrowing trend in market breadth suggests that the market rally has become less reliant on a handful of stocks.
Economic Data and Profit Growth: The broadening of the market's performance can be attributed to resilient economic data, which has in turn fueled better-than-expected profit growth and overall stock market performance. Despite the narrowness in earlier months, the current situation indicates a more diversified and stronger market landscape. Notably, the consumer sectors, construction, travel, and streaming/gaming industries have exhibited particularly strong profit growth.
Moderate Broadening and Mega-Cap Tech Stocks: The broadening of market performance has been moderate, indicating that while the concentration of gains has lessened, mega-cap tech stocks still hold significant sway over the market. Although the concentration has reduced from peak levels seen in April/May, the top 10 stocks still account for over 30% of the index. This level is historically high, suggesting that these stocks continue to wield substantial influence.
Earnings Contribution vs. Weight: An interesting disconnect exists between the weight of the top 10 stocks in the index and their contribution to earnings. While their weight has decreased from peak levels, the earnings contribution remains near pre-COVID levels but is below the pandemic-era highs. This mismatch suggests that the valuation of these stocks might not be entirely aligned with their earnings potential.
VIX and Confidence: Despite the concentration of gains and valuation concerns, the VIX (Volatility Index) has remained at historically low levels. This suggests that market participants have grown increasingly confident in a soft landing scenario, wherein the economy avoids a severe downturn. Low volatility could be indicating optimism about the market's resilience.
Inflation and Fed's Hawkish Stance: The sustainability of the market's performance is closely tied to the trajectory of inflation. If core CPI (Consumer Price Index) remains sticky and continues to rise, it might prompt the Federal Reserve (the Fed) to maintain a hawkish stance on monetary policy. This could increase the likelihood of a recession, as tighter monetary conditions might impact economic growth.
Earnings Revision and Vulnerability: In the event of a more hawkish Fed stance and increased inflation, there is a risk of earnings being revised lower. Given that valuations are already stretched, such a scenario could leave the market vulnerable to corrections or declines. The concentrated gains in specific sectors, especially mega-cap tech stocks, might experience more significant impact.
Investment Strategy: Given the potential for increased market volatility and the risk associated with stretched valuations, investors are advised to take advantage of historically wide valuation dispersion. This involves focusing on low beta stocks, which are characterized by stable cash flows and solid balance sheets. This strategy aims to mitigate risks and capitalize on stability amid uncertain market conditions.

Previous update:

Institutional opinions

Potential Market Correction: The analysis suggests that the recent pullback in the markets might be indicative of a larger correction in the coming months. Given the historical data and the current market conditions, a correction in the range of 5% - 10% is anticipated. However, the analysis also indicates that this correction is not expected to derail the overall bull market, which is believed to be in its early stages.
Volatility in August and September: August and September are historically more volatile months in the markets. This suggests that investors should be prepared for increased market fluctuations and potentially higher levels of uncertainty during this period.
Market Fundamentals: The analysis highlights that the rally in the market has been supported by better fundamentals, including improving inflation trends, a potential pause in Federal Reserve rate hikes, and positive economic growth. These factors have contributed to the market's upward momentum.
Earnings Recovery: Despite negative earnings growth in the near term, the analysis predicts a gradual improvement in earnings growth in the second half of the year and through 2024. This anticipated recovery in earnings could be a positive driver for market performance.
Fed's Role: The Federal Reserve's actions are expected to play a role in the market's future trajectory. While the Fed is likely to remain on hold through 2023, it might signal potential rate cuts in 2024 if inflation approaches the 2.0% target. The Fed's decisions could influence market sentiment and direction.
Long-Term Investment Opportunities: If a market pullback or correction occurs, it could present an opportunity for investors who didn't fully participate in the earlier rally to enter the market at potentially lower prices. The analysis suggests that both equities and longer-duration bonds could offer compelling investment opportunities.
Sector Leadership: The analysis identifies potential sectors that could lead the market higher. These include small-cap stocks, cyclical sectors like industrials and materials, consumer discretionary, and international equities. Additionally, artificial intelligence (AI) and technology sectors are also expected to remain strong.
Market Recovery Time: Historical data indicates that while pullbacks are common after strong rallies, markets tend to recover within about six months on average. The recovery time could be even shorter if the extreme highs are excluded.
Cautious Optimism: Overall, the analysis suggests a sense of cautious optimism. While a correction might be imminent, the long-term outlook for the market remains positive due to favorable fundamentals and potential catalysts.
Emerging Markets and Global Supply Chain Rewiring: The analysis suggests that emerging markets (EMs) are better positioned to withstand volatility and benefit from the rewiring of global supply chains. As nations prioritize security and resiliency over maximum efficiency, many EMs are expected to benefit from the shift in supply chain dynamics, bringing production closer to home.
Fragmentation of Globalization: The data indicates that globalization is under pressure, and a world of fragmentation is emerging with competing defense and economic blocs. The rise of multi-aligned nations and the changing priorities of countries and companies are expected to accelerate the rewiring of supply chains. Selected EMs are seen as beneficiaries of this trend.
Preference for EMs: The analysis suggests that, in the short term, emerging markets may be better positioned to withstand volatility compared to developed markets (DMs). EM central banks are nearing the end of their rate hiking cycles, which could provide some stability. However, EMs are not immune to risks.
Switching Bond Preferences: The analysis indicates a preference for hard currency EM debt over local currency debt. EM hard currency debt is considered more attractive due to its diversification and the potential impact of supply chain rewiring on the currency. This shift in preference is expected to be implemented on a six- to 12-month tactical horizon.
Favoring Specific EM Sectors: The analysis highlights specific sectors within EMs that are expected to benefit from the rewiring of supply chains. These sectors include commodities like oil, chemicals, industrial manufacturing, battery and memory supply chains, nickel, cobalt, and lithium. The push to reshore production closer to home, particularly in areas like semiconductors, is also seen as an opportunity.
Rise of Mega Forces: The concept of "mega forces," which are structural changes with the potential to reshape economies and sectors, is introduced. These forces include digital disruption (AI), geopolitical-driven rewiring of globalization, transition to a low-carbon economy, aging populations, and changes in the financial system. Identifying catalysts and beneficiaries of these mega forces is crucial.
Greater Volatility and New Regime: The analysis emphasizes that the current environment is characterized by greater volatility and a departure from the past four decades of steady growth and inflation known as the Great Moderation. Central banks are expected to keep policies tight to counter inflationary pressures.
Elevated Wage Pressures: The data indicates that wage pressures are persistently high, despite hopes of inflation falling back to target levels. The labor market is tightening due to factors like aging populations, which could contribute to sustained wage growth and potential challenges in achieving inflation targets.
Granularity and Security Selection: The analysis highlights the importance of granularity and security selection in the current market environment. With increased volatility and divergent security performance, opportunities can be found through more targeted approaches and uncorrelated exposures.
Overweight on AI: The analysis suggests an overweight position in artificial intelligence (AI) investments. AI is considered a significant structural change that could impact various sectors and industries, and the potential benefits of AI adoption may be more pronounced within developed markets.
Long-Term Bond Yields Rising: The analysis anticipates a rise in long-term government bond yields due to fiscal challenges and increased U.S. Treasury bond issuance. The downgrade of the U.S. credit rating and borrowing needs could lead investors to demand higher term premiums.
Reshoring and Manufacturing Super Cycle:?The U.S. is experiencing a manufacturing supercycle, driven by mega-legislative programs and investments in areas like solar panels, electrical vehicles, semiconductors, and charging stations. The manufacturing boom has exposed weaknesses, such as a lack of skilled labor, shortages of critical metals and minerals, and global industrial subsidy races. Investment implications: Investors could consider exposure to infrastructure-related industrial companies, leaders in renewable energy, electrical vehicles, batteries, and charging stations, as well as low-carbon technologies and transmission technologies.
El Nino and Global Markets:?El Nino, a cyclical warming of the Pacific Ocean, is predicted to impact global markets by increasing agricultural commodity price inflation, affecting interest rates, and potentially leading to fiscal and external imbalances in import-dependent countries. Agricultural resource scarcity remains a long-term trend, and the onset of El Nino could accelerate the effects of higher food prices. Investment implications: Investors may see higher prices for agricultural commodities, increased demand for products that boost agricultural yields, and potential benefits for equities along the agribusiness supply chain.
Equity Market Trends:?The equity market has shown resilience and a broadening of participation, with various sectors like Materials, Industrials, Energy, and Financials leading the advance. Weaker seasonality, elevated valuations, bullish sentiment, and the lagged effects of monetary policy tightening could pose challenges for the equity market. Investment implications: Investors could consider a balanced approach to portfolio construction, staying attentive to potential headwinds, and using periods of market weakness to rebalance portfolios.
Challenges and Considerations for Reshoring:?While reshoring in the U.S. has led to investments and growth, it faces challenges such as a shortage of skilled labor, lack of secure domestic supply for critical metals and minerals, global subsidy races, and the potential negative consequences of concentrating production. The reshoring strategy could lead to delayed projects, rising wages, and supply chain vulnerabilities. Investment implications: Investors should be aware of potential pitfalls and consider diversification strategies that align with long-term economic growth and adaptability.
Unintended Consequences of Reshoring:?Reshoring could inadvertently lead to economic inefficiencies, lower profit margins due to excess capacity, and greater risks of supply disruptions. A diversified supply source across countries may offer better resilience to shocks and promote more sustainable economic growth. Investment implications: Investors might consider diversifying supply chains and investment portfolios to mitigate the risks associated with potential unintended consequences of reshoring efforts.
Impact of the Debt Downgrade:?The recent downgrade of the U.S. credit rating by Fitch due to expected fiscal deterioration, high government debt, and governance issues may have consequences for investors. The 2011 downgrade by S&P had a significant market impact, resulting in stock market declines and falling Treasury yields. The initial reaction to the Fitch downgrade has been less volatile, but investors should remain cautious.
Rising Interest Costs and Yield Demands:?Rising interest costs to service the U.S. debt are becoming challenging, and higher interest rates could further accelerate these costs. Investors tend to demand higher yields to offset increased risk as debt service costs become harder to sustain. This can lead to higher borrowing costs for the U.S. government.
Treasury Issuance and Market Liquidity:?The U.S. Treasury is expected to issue around $1 trillion worth of Treasury securities, which could reduce market liquidity. This increase in issuance coincides with the Federal Reserve reducing its balance sheet, potentially impacting market dynamics.
Capital Diversion and Economic Impact:?Increased federal debt issuance could redirect private investment spending and consumption towards Treasury debt, limiting capital available for private investment. This redirection of capital could result in lower economic output, incomes, investment of capital, and investment returns.
Policymaker Flexibility and Economic Shocks:?As the U.S. government's debt load grows, policymakers may have less flexibility to respond to future economic shocks and unexpected events. This reduced flexibility could lead to more significant negative economic impacts from future shocks due to limitations in fiscal responses.
Structural Strengths and Economic Performance:?Despite fiscal concerns, the U.S. benefits from structural strengths, including the dollar's reserve currency status and a diversified and advanced economy. Current economic performance is above expectations, but the potential for recessionary conditions could complicate the near-term fiscal outlook.
Long-Term Implications for Investors:?While the immediate impact of the Fitch downgrade has been modest, investors should monitor the U.S. fiscal challenges over the medium- to long-term. If these challenges persist, investors could face higher interest rates and borrowing costs, especially for longer-maturity securities. Increased volatility in equity markets could occur as rising interest rates compete with equities for investor attention, and policymakers might lack tools to buffer unexpected economic events.
Labor Market Dynamics:?The employment report showed a nuanced picture of the labor market, with job openings and payroll gains coming in below expectations. Wage growth surprised slightly on the upside, which prompts the question of whether this trend will continue or revert to its previous easing pattern.
Earnings Season Trends:?The 2Q23 earnings season revealed that more than 70% of companies beat earnings estimates despite softer revenues. In the face of input cost inflation, companies had been raising prices to protect margins. However, as inflation eases further, pricing power is likely to diminish.
Shift in Corporate Behavior:?The landscape is shifting as inflation eases, causing companies to experience reduced pricing power. To defend margins, companies may be compelled to embrace layoffs and cost-cutting measures. This could lead to softer wage growth and moderation in the labor market overall.
Industry-Specific Effects:?Certain sectors, like IT and other service-related industries, have already experienced moderation in wage growth due to layoffs in the previous year. Goods-producing industries and trade, transport, and utilities might experience a lag in the impact on wage growth due to sustained high job opening rates and unionization.
Federal Reserve's Response:?Chairman Powell's recent comment suggests that the Federal Open Market Committee (FOMC) might not need to wait for inflation to return to 2% before considering rate cuts. A less robust wage growth environment should provide the Fed with room to pause and eventually cut rates in the coming year.
Path to a Soft Landing:?The data indicates that a soft landing for the economy is becoming increasingly visible. However, historical precedent shows that soft landings are rare occurrences. The timeline to add duration (investing in longer-term fixed income securities) has been extended due to recent increases in interest rates.
Investment Implications:?Investors should consider taking advantage of the extended timeline to add duration to their investment portfolios, given the recent rise in interest rates. Embracing higher-quality sectors within the fixed income universe is recommended as preparation for lower inflation and softer economic growth in the upcoming year.
U.S.: Stock Market Mixed:?The U.S. stock market ended the week mixed, with value stocks outperforming growth stocks. Concerns about rising long-term interest rates and conflicting inflation signals contributed to this mixed performance.?Corporate Earnings Season:?The quarterly earnings reporting season is winding down, contributing to lighter trading volumes. Health care stocks received a boost from positive developments in diabetes drug efficacy, while information technology stocks underperformed due to worries about rising rates.?Interest Rates and Federal Reserve:?Inflation data and statements from Federal Reserve officials suggest a mixed outlook on interest rates. The Federal Reserve may consider rate cuts in the coming year if wage growth remains weak. The bond market saw increased activity, and the yield on the 10-year Treasury note rose due to producer price inflation.
Europe: European Stocks:?European stocks showed little change overall. Sentiment was affected by concerns about a potential economic slowdown in China and a windfall tax on bank profits announced by the Italian government.?European Bond Yields:?European government bond yields rebounded, driven by the possibility of sustained inflationary pressures. Expectations for the European Central Bank (ECB) to maintain an ultra-accommodative stance increased due to uncertainty in the economic outlook.
Japan: Japanese Stock Market:?Japanese stock markets saw gains, with positive earnings forecasts from major companies and the resumption of Japan-bound group tours for Chinese citizens contributing to the positive sentiment.?Monetary Policy:?The Bank of Japan (BoJ) is likely to maintain its ultra-accommodative stance due to signs of easing inflationary pressure and slowing wage growth. The BoJ's commitment to yield curve control with flexibility remains in place.
China: Chinese Stocks:?Chinese stocks faced a retreat as evidence suggested that the country's economic recovery might have peaked. Concerns about deflationary pressures offset optimism about stimulus measures to boost consumer spending.?Inflation Data:?China's inflation data indicated a decline in both consumer and producer prices, raising concerns about weak demand in the economy. Trade and lending data also came in below expectations, indicating a loss of momentum in the recovery.?Property Sector:?China's property sector continues to face challenges, as evidenced by property developers struggling with liquidity issues. The sector has been affected by slowing sales and high debt levels.
Colombia and Mexico: Inflation Trends:?Both Colombia and Mexico reported inflation data. While both countries experienced month-over-month increases, disinflation is evident in sequential inflation data, indicating some stability in price growth.?Monetary Policy:?Central banks in Colombia and Mexico are likely to maintain cautious stances on monetary policy, with potential interest rate adjustments in response to inflation trends and economic conditions.
Market Momentum and Pullback:?The recent market momentum has slowed down, partly due to the U.S. debt downgrade by Fitch. This suggests that the odds of a pullback in the market have increased. There are indications of weakness beneath the surface, with new lows expanding even during market upside. Additionally, key stocks have experienced breakdowns, and the S&P 500 has fallen below its 20-day moving average for the first time since May.
Investor Behavior and Support Levels:?Despite the recent pullback, the "buy the pullback" investor mentality is likely to come into play, potentially finding support around the 50-day moving average (DMA) of the S&P 500 at 4427. The degree of investor conviction and price action in the coming days and weeks will provide insights into the market's future direction. If a minor bounce occurs and is followed by a decline below the recent low, there's a higher likelihood of an extended back-and-forth period.
Earnings Season and Price Reactions:?The Q2 earnings season is nearing its end, with positive surprises from 79% of S&P 500 companies reporting. However, despite solid results, price reactions have been relatively muted, possibly due to stocks being priced for perfection leading up to the earnings season. Stocks that reported beat and raise results have shown positive post-results price changes, while others have seen negative reactions, contributing to the view that valuations may have priced in a lot of good news.
Technology Sector:?The Technology sector, which has been a market leader, is showing signs of consolidating its strength from the first half of the year. The sector's index has broken its 50-day moving average, and relative strength is declining. This consolidation might indicate a temporary breather. The semiconductor subsector is also showing signs of fatigue, as it moves below its 50 DMA for the first time since June. Earnings reports from semiconductor companies may influence the sector's performance.
Oil and Energy Sector:?Oil prices have exhibited renewed strength, with WTI crude oil trading above its 200-day moving average. This improvement has positively impacted the Energy sector, which has seen relative strength breaking above downtrend resistance. This improvement might attract investor attention to the out-of-favor sector. However, the Energy sector's relative performance has historically moved counter to the S&P 500, potentially indicating uncertainties in the market, inflation expectations, and economic activity.
Market Technicals:?The technical analysis of the S&P 500 suggests that the recent slowdown in momentum and the breach of moving averages might signal a potential pullback or consolidation period. The market's behavior around support levels and the overall trend of the average stock's relative strength could provide insights into the health of the market.
Economic Data:?Upcoming economic data releases, including July CPI, PPI, Retail Sales, Industrial Production, and Leading Economic Indicators, will play a significant role in determining the degree of weakness or the market's ability to recover from the current slowdown. Positive data could potentially support equities, while weaker data might contribute to further market challenges.
Interest Rates and Fed:?Despite economic resilience in the services sector, the risk of higher inflation remains due to elevated wage growth. This could keep the Federal Reserve cautious and alert. Economic variables, such as interest rates and weak bank lending, may weigh on economic activity in the coming months.
Equity Market Expectations:?Equity markets are currently testing their first support levels and are likely to experience a bounce in the short term due to becoming oversold from a trading perspective. However, despite the short-term bounce, the overall view is that equity markets are peaking intermediate-term after a significant surge from Q4 2022 lows. The current weakness is consistent with a pullback into the seasonally weak period extending into September. While a bounce is expected, it's likely to be relatively short-lived, followed by further choppy sideways trading rather than the beginning of another multi-month advance.
Support Levels and Market Cycle:?The S&P 500 is currently at first support around 4,500, near its blue 50-day moving average and Q2-Q3 uptrend line. There is additional support at 4,448, and if that doesn't hold, next support is at 4,325. The view is that the S&P 4,300 and Nasdaq 13,150 are important support levels that are unlikely to be broken if markets remain weak through Q3. The current pullback is seen as a normal and healthy pause within the early stages of a new market cycle that began in Q4 2022.
US 10-Year Yield and Interest Rates:?The US 10-year yield tested and then stalled below its next key technical band between 4.24% and 4.33%. While there was concern about rates accelerating higher, short-term indicators becoming overbought suggested a stall, which has been reinforced by this week's pullback. The expectation is that 10-year yields will not surge above the 4.24-4.33% range. Key downside levels for yields are identified at 3.85 and 3.67%.
Natural Gas and Energy Sector:?Natural Gas has broken out above its June-July trading range highs, part of the broader improvement seen in the energy sector. Short-term pullbacks in the energy sector are expected to be short-lived, and the breakout in natural gas supports the idea of a broader bottoming pattern with potential for further upside.
Healthcare Sector Rotation:?The Healthcare sector has been trading sideways since April 2022 and underperforming the S&P 500 in relative performance. However, there's evidence of improvement developing in the Healthcare sector, which is seen as part of normal sector rotation into a seasonally weak period moving into September.

S&P Global 1 年前

Weekly market insights

Machine Learning Intelligence 1 年前

Weekly market insights

Machine Learning Intelligence 1 年前

Previous update:

Institutional Opinions

U.S. Credit Downgrade Impact: The recent credit downgrade of U.S. government debt by Fitch is not expected to have a significant impact on the fundamental drivers of the economy and markets. While the downgrade raises concerns about the growing federal debt burden, U.S. Treasuries are still considered the world's premier safe asset due to their liquidity and market depth.
Stock Market Outlook: The data suggests that the evolution of growth and inflation provides a solid foundation for stocks to continue in a sustainable uptrend. Despite the credit downgrade and potential downside risks, the economy has been growing above-trend, unemployment is near historic lows, and credit spreads are narrow, which supports the stock market.
Positive 12+ Month Outlook: The equity market is currently riding a wave of soft-landing optimism, and the trend is favorable. The S&P 500 has been posting consecutive months of positive performance, and historical data suggest solid returns over the next 3, 6, and 12 months. The overall market message is that strength often begets strength, supporting a positive 12-month stance on equities.
Q2 Earnings Season: Q2 earnings season has been strong, with a significant percentage of S&P 500 companies beating bottom-line estimates. Forward estimates are also improving, indicating that fundamentals are holding up better than previously believed. Market leaders in sectors like Consumer Discretionary, Technology, Industrials, and Communication Services have delivered notable results.
Economic Soft-Landing: The economy has performed well so far, buoyed by excess savings from Covid stimulus. However, there are concerns over the path of inflation, which could impact the Federal Reserve's efforts to lower it. Additionally, rapid Fed tightening since last year may lead to credit conditions tightening and indicators pointing to economic weakness ahead. The market consensus is leaning towards an economic soft-landing, but potential disruptions could create doubt among investors.
Technical Analysis: From a technical perspective, the S&P 500 has broken out in early June and has been trading above its 20-day moving average. Barring a significantly negative shock, the index is likely to hold above support levels on a pullback. The 20-day moving average (~4515) is the first level of support to monitor on the downside.
Credit Conditions and Defensive Sectors: The Senior Loan Officer Survey indicates increasingly tight lending standards, which could precede economic contraction. Tight credit conditions may impact equity prices from current levels. For investors looking to add defensive attributes to portfolios, Health Care and Utilities sectors are highlighted as low-beta options.
U.S. Equities: The major U.S. equity benchmarks started August with a down week, driven by rising Treasury yields and an unexpected downgrade to the U.S. government's credit rating. While some mega-cap names like Amazon performed well and beat expectations, others like Apple traded down due to mixed results, especially in its iPhone sales. The U.S. government's credit downgrade and the slowdown in hiring from the faster pace at the start of the year might have contributed to the decline in equities.
Interest Rates: The yield on the benchmark 10-year U.S. Treasury note increased from the previous week, reaching almost 4.20%. Expectations of higher issuance by the Treasury Department pushed yields higher. In contrast, the Bank of England raised its key interest rate by a quarter of a percentage point to 5.25%, indicating that rates are likely to stay high for some time to return inflation to the 2% target. The UK housing market remains weak amid high mortgage rates.
European Equities: European equities declined as higher U.S. bond yields and disappointing earnings reports affected investor sentiment. The UK's housing market showed a significant decline in house prices, and Eurozone inflation remained well above the ECB's target. However, the Eurozone economy rebounded in the second quarter, though forward-looking indicators suggest a weaker start to the third quarter.
Japanese Markets: Despite strong corporate earnings, Japanese stock markets fell as global investor risk appetite was dampened by the U.S. sovereign credit rating downgrade. The Bank of Japan's monetary policy adjustment led to a rise in the 10-year Japanese government bond yield to a nine-year high.
Chinese Stocks: Chinese stocks rose as Beijing announced new measures to revive consumption and the People's Bank of China pledged to support the real estate market. The official manufacturing Purchasing Managers' Index rose to 49.3, just below the growth threshold for the fourth consecutive month. The property sector, however, continued to decline for a second month with a significant drop in new home sales.
Brazil's Central Bank: The Central Bank of Brazil kicked off an easing cycle by lowering its benchmark interest rate by 50 basis points, becoming one of the first global central banks to ease monetary policy after aggressive tightening during the post-pandemic inflationary surge.
Peru's Inflation: Peru's consumer price index for July increased at a slower pace compared to June, indicating well-behaved inflation and the potential for the central bank to introduce an easing bias or cut rates in the future.
Bond Market Outlook: Bonds may experience some pressure but could rally into 2024 as the end of Federal Reserve tightening becomes clear. The recent rise in bond yields could be attributed to economic strength, Bank of Japan policy changes, and an uptick in commodity prices. However, the pullback in bonds is seen as a culmination of several factors, and yields are expected to stay range-bound before potentially dropping in 2024.
Labor Market and Wage Growth: The July jobs report provided mixed takeaways, indicating that the labor market is cooling but only slowly. Wage growth remains a concern for the Federal Reserve as it aims to manage inflation. The unemployment rate is at its lowest since the 1960s, and wages grew at a faster-than-expected pace.
Short-term Market Volatility: The recent credit downgrade and other economic factors could lead to higher volatility in the second half of the year. While stocks are expected to remain in an uptrend, short-term investors may take profits, leading to market fluctuations.
Investment Recommendations: Investors may consider diversifying into lagging segments of the equity market with lower valuations. Dollar-cost averaging can be employed to take advantage of market swings. Properly laddering fixed-income holdings is recommended to benefit from potential lower yields in 2024.
Near-Term Pause in Equities: The equity markets are expected to experience a near-term pause as Q3 seasonality becomes a headwind. Evidence of peaking short-term is visible, and key support levels are being tested. Further weakness in the coming weeks is anticipated.
Technical Levels for S&P and Nasdaq: The S&P and Nasdaq are challenging/breaking the rising 20-day moving averages near key support levels. A break below these levels could lead to further downside movement towards the next support levels.
US 10-Year Yields: The US 10-year yields are challenging important upside levels between 4.0-4.9%. A close above 4.09% could signal further upside movement, but interest rates are expected to stall at the 4.24-4.33 range due to short-term momentum likely becoming overbought.
Seasonality Impact: Seasonality studies suggest that September has often been a period of weakness for equities. Given the current view of the equity markets, the balance of Q3 is expected to remain volatile as markets consolidate gains from Q1 to Q3.
Sentiment Surveys: Sentiment surveys indicate positive sentiment among investors, but it is expected to become less of a tailwind tactically. Bullish sentiment may decline during a market pullback, acting as a healthy check on overly bullish investors.
Long-Term Perspective: Despite the near-term pause and potential weakness, the longer-term cycle backdrop is viewed as positive. Pullbacks are seen as a healthy technical development and an opportunity to continue building equity exposure in secular and cycle growth stocks through the Fall.
U.S. Equities vs. International Developed Markets: The past decade has seen a significant outperformance of U.S. equities compared to international developed market stocks. However, historical patterns suggest that market leadership tends to rotate over the long term. Therefore, it is possible that international markets could experience a period of outperformance in the future, especially given their relatively lower valuations and potential benefits from the shift away from globalization.
U.S. Dollar and Currency Headwinds: The persistently strong U.S. dollar has curtailed returns for USD-denominated investments. However, according to RBC Global Asset Management's fair value model, the U.S. dollar remains overvalued by more than 20 percent based on purchasing power parity. This suggests that the U.S. dollar could enter a multiyear weakening cycle, which would likely improve currency-adjusted returns for international equities in the years ahead.
Geopolitics and Trade Relations: Ongoing geopolitical tensions and the shift away from globalization may create opportunities in international equity markets. Companies in Europe and Japan could serve as useful ways to position for a wider range of potential economic outcomes in an era where protectionist policies are likely to become increasingly common.
Interest Rates and Economic Conditions: Interest rates in the U.S. and Canada have been trending upward, with central banks engaging in rate hikes to combat inflationary pressures. The trajectory of inflation and economic data will play a crucial role in determining future rate decisions and market expectations.
Market Leadership Cycles: While U.S. equities have been dominant in recent years, history shows that market leadership tends to rotate between different regions over the long run. As the U.S. equity market becomes top-heavy, opportunities in international markets could provide compelling ways to broaden sector and company exposures at relatively less demanding valuations.
Investor Sentiment: Investor sentiment towards U.S. equities has been favorable, but it may become less of a tailwind for stocks as pullbacks and uncertainties occur. Investors are advised to maintain a strategic allocation to international equity markets to diversify risk and returns, benefit from income streams, and gain exposure to broader geopolitical trends.
Stock Market Outlook: The analysis suggests that the stock market may struggle to move much higher in the near term. Valuations are stretched, and the risk-versus-reward tradeoff is not attractive. The recommendation is for investors to exercise patience and wait for better opportunities to put money to work in the stock market over the coming quarters.
Vulnerability of Technology Sectors: If inflation starts to rise again and interest rates continue to increase, the technology sectors that have driven the recent rally could be vulnerable to sharp pullbacks. The recommendation is to be cautious in these sectors and to focus on overweighting quality sectors that have underperformed during the rally and have good long-term revenue-generation prospects.
Emphasizing Capital Preservation: The view is to emphasize capital preservation while the sentiment-driven market becomes more overextended. This involves securing dividend streams for income and positioning for potential long-term capital gains through a disciplined and incremental approach like dollar-cost averaging.
Long-Term Perspective: For investors looking at a longer time horizon of two, four, or more years, equities are still considered one of the best ways to build wealth over time. Putting money into the stock market in a systematic way over time has historically paid off in the long run, and this trend is expected to continue in the decades ahead.
Fear of Missing Out: The analysis suggests that the fear of missing out on a nearer-term tech-sector rally should not drive investment decisions. Waiting for the earnings outlook to improve and avoiding risking savings in a sentiment-driven rally is advised.
Federal Reserve Policy: The Federal Reserve hiked rates by 25 basis points at their July meeting to a range of 5.25%-5.50%. Despite the rate hike, the messaging from Chairman Powell was somewhat dovish, emphasizing continued data dependency in policy decisions. The Fed is likely to closely monitor inflation data, particularly the July and August CPI reports, to make decisions on further rate hikes in their September meeting. If there is mounting evidence of a sustained disinflation trend, the Fed may consider pausing rate hikes.
Economic Growth: The first estimate of 2Q23 GDP showed that the economy grew at a better-than-expected annualized rate of 2.4%. This growth was driven by strength in consumption and business fixed investment, indicating resiliency in economic growth.
Labor Markets: Unemployment claims remain low, indicating a strong labor market. Additionally, the Employment Cost Index (ECI) rose 1.0% in the second quarter, suggesting moderate wage gains. The Fed is likely to closely monitor wage growth relative to inflation trends.
Inflation: The data showed progress on disinflation, with the core services ex-housing PCE rising at a modest rate of 0.24% in June, down from the previous three months' average of 0.44%. If disinflation trends continue, it may influence the Fed's rate hike decisions.
Market Sentiment: Despite the Fed rate hike and messaging, markets appear relatively unfazed. Investors seem to be looking beyond incremental Fed tightening, suggesting that they may be more focused on other factors influencing market sentiment.
Rising Global Yields: The tightening of policy by major central banks, including the Bank of Japan's shift to relax its yield curve control, may lead to rising Japanese bond yields. This could also pull global yields higher due to the strong gravitational pull between developed market (DM) bond yields. There is potential for further tweaks to the Bank of Japan's policy, contributing to an increase in developed market bond yields.
U.S. Jobs Data: The upcoming U.S. jobs data is likely to show still-low unemployment, confirming a tight labor market. However, it is noted that the low unemployment rate may be a result of structural worker shortages rather than a sign of a buoyant economy. The Federal Reserve may be misreading the economy's strength based on this indicator, and there is a possibility that the Fed may hike more than markets expect and then cut rates later.
Disinflation Trend: Inflation data in the euro area and Japan suggests a cooling trend. The European Central Bank (ECB) has already signaled an end to its tightening bias and is moving towards data-dependency. If disinflation trends continue, it could influence central bank policies and global yields.
Market Sentiment: Markets seem to have come around to the view that central banks will keep policy tight to lean against inflationary pressures. This is not a friendly backdrop for broad asset class returns, and central banks may be forced to hold policy tight in a world shaped by supply constraints.
Investment Themes: Given the potential for rising global yields and central banks being forced to keep policy tight, there is an overweight preference for short-dated U.S. Treasuries and quality in both equities and fixed income. Investors are advised to consider opportunities for security selection, relative value, and exposure to mega forces, such as artificial intelligence (AI), geopolitical shifts, low-carbon economy transition, aging populations, and changes in the financial system.
Thematic Exposure in Portfolios: The post-pandemic world has accelerated certain megathemes while some were exaggerated. Investors should consider thematic exposure in portfolios, especially in areas like generative artificial intelligence (AI), which is seeing a significant opportunity.
Bullish Catalysts for Equities: The equity market has rallied into the second half of the year, but uncertainty remains due to the macroeconomic backdrop. Investors should watch for signals such as corporate earnings rebound, Fed funds rate peaking, a potential recession as a "reset," increased capital expenditures, a weakening U.S. dollar, realignment of volatility gauges, and improvements in the fundamental backdrop to support a sustainable, broad-based recovery.
Entrepreneurial Spirit in the U.S.: Despite challenges like a potential recession, rising costs, and tight labor markets, the entrepreneurial spirit in the U.S. remains strong. The number of business applications filed in the first half of the year has surged, indicating confidence in the economy and supporting the bias toward U.S. assets in portfolio construction.
Portfolio Considerations: Given the level of portfolio drift in certain areas, investors should actively rebalance portfolios. Transitioning to a new macroeconomic regime with elevated risks requires building diversified portfolios across and within asset classes, including alternatives. The current conditions warrant a neutral view on equities and fixed income relative to strategic benchmarks, with emphasis on balance and diversification.

Previous update:

Institutional Opinions

The Federal Reserve may have completed its rate hike cycle, and rate cuts are unlikely this year. However, rate cuts may be signaled early next year if inflation moves toward a 2% target, and the Fed may remain on an extended rate pause through the beginning of 2024.
The European Central Bank (ECB) and Bank of Japan (BoJ) have enacted monetary policy decisions, raising rates and making policy tweaks respectively. Global push higher in interest rates may incrementally raise borrowing costs for consumers and corporations, while supporting easing inflation trends worldwide.
The US economy is experiencing resilient growth, with GDP growth coming in above-trend speed for the second quarter. Despite some areas of easing, there are no signs of an imminent recession or downturn, and the probability of an outright recession has declined.
Inflation continues to moderate even as growth accelerates, which is a positive signal for the Fed and markets. Price pressures can ease even if growth remains solid.
Market sentiment seems to be optimistic, embracing a goldilocks-type scenario, as better macro trends, including potential rate hike pauses, moderating inflation, and resilient growth, contribute to a broadening of market leadership.
Despite the strong rally, there are still compelling opportunities in both the equity and bond markets. Some bouts of volatility may still occur, but there are prospects for adding quality positions at lower prices.
In equities, positioning for a further broadening of market leadership, including small-cap stocks and cyclical sectors, may be favorable. Complementing growth stocks with these sectors and some international exposure could yield better performance.
In bond markets, longer-duration bonds, particularly in the investment-grade space, present an attractive opportunity to complement shorter-duration and cash-like assets. Extending duration ahead of potential rate cuts could provide better yields and potential price appreciation.
Central banks are expected to hike policy rates this week, and markets anticipate rate cuts due to cooling inflation. However, central banks are likely to hold tight on rates, leading to a continuation of the inflation fight.
U.S. stocks rose last week on initial earnings updates, but earnings are expected to contract in the second half of 2023 due to wage gains impacting profit margins.
The Federal Reserve and the European Central Bank (ECB) are likely to raise interest rates again this week. The Bank of Japan may opt for loose policy to sustain above-target inflation, given fewer supply constraints.
Soft June U.S. core CPI inflation has revived hopes for rate cuts in 2024, which may fuel a bull run across assets for some time. However, this optimism could be challenged as the disconnect between fast-falling inflation and stronger-than-expected economic activity becomes apparent.
Core inflation across developed markets is falling from last year's highs, but the journey back to central banks' 2% policy target remains bumpy. Spending shifting back towards services is causing goods inflation to fall, but persistent services inflation driven by wage pressures may keep core inflation above 2%.
Central banks, including the Fed, ECB, and Bank of England, are facing the challenge of dealing with lower goods prices and persistent services inflation. They are expected to push ahead with their inflation fight, even though growth is weaker in the euro area and the UK.
In this environment, holding tight on monetary policy is likely to be the prevailing approach, with central banks forced to keep policy tight to lean against inflationary pressures.
Given the challenges in the macro environment, investors are advised to look beyond broad asset classes and focus on specific investment themes, such as income generation through short-dated U.S. Treasuries, quality investments in equities and fixed income, and opportunities arising from mega forces like artificial intelligence (AI) in multi-country, multi-sector investment cycles.
Maintain a neutral weight on small-cap stocks: Despite the recent strength in the Russell 2000 Index, the absence of several macro factors that typically support sustained outperformance for small-cap stocks calls for a cautious approach. It is important to monitor the pickup in cyclical momentum and the economywide profits cycle before considering an upgrade.
Focus on quality bias across equities, including small-caps: Given the headwinds for small-caps due to the profits cycle and contracting margins, a quality bias is recommended in equity investments. Companies with strong fundamentals and lower leverage may be better positioned in the current environment.
Favor hard assets and hard power in the portfolio: The risks associated with China's dominance as the "refinery to the world" for critical metals and minerals suggest a focus on hard assets (such as energy, metals, and minerals) and hard power (including defense) in investment strategies. This is important in light of geopolitical tensions and the potential disruptions in the supply chain.
Monitor liquidity conditions and Federal Reserve actions: The concerns over liquidity and volatility resulting from increased Treasury bill issuance have been addressed by the Federal Reserve's borrowing program. Investors should closely watch liquidity conditions, bank reserves, and the interplay of the TGA, RRP, and Quantitative Tightening (QT) for potential impacts on risk asset sentiment.
Consider extending duration in fixed income: With the economy transitioning to a new macroeconomic regime and risks still elevated, investors may consider lengthening duration in fixed income investments. This should be based on the shape of the yield curve, real rates, and the potential for a recession in the next six to 12 months.
Diversify portfolios across and within asset classes: As the macroeconomic environment undergoes a transition, building diversified portfolios becomes imperative. Qualified investors should carefully assess their portfolio drift and make adjustments as needed to align with their risk tolerance and investment objectives.
Real Estate Investment Trusts (REITs) may continue to underperform other S&P 500 sectors: The historical pattern, where REIT relative strength has moved in two-year cycles of positive and weak performance, suggests that REITs could remain weak relative to other sectors into 2024. The unfavorable rating on REITs is based on late-economic-cycle performance, rising delinquencies, tightening lending standards, and other negative real estate indicators.
Real Estate Valuations may impact REIT relative strength: REITs currently trade at a 5.4% discount to their underlying real estate holdings, which historically is considered decent. However, historical patterns indicate that relative strength peaks in REITs often align with periods when real estate becomes relatively expensive, and troughs align with cheaper real estate periods. A reversal in relative strength could be triggered by changes in real estate valuations, though the exact threshold for this shift is uncertain.
Equities may face headwinds in the second half of 2023: The market's recent rise has been supported by factors such as monetary policy, liquidity-related factors, economic growth, and prospects for artificial intelligence. However, many of the positive factors are now priced into the market, leading to richer valuations. The expectation of additional interest rate hikes, declining liquidity, and weakening economic indicators may lead to headwinds for equities in the second half of 2023.
Residential Mortgage-Backed Securities (RMBS) offer potential opportunities: RMBS is currently rated neutral and provides relatively attractive yields compared to investment-grade corporate bonds. The sector is well-positioned to offer risk-adjusted excess returns in the second half of 2023, especially if Treasury yields remain in a tight range. RMBS has historically shown higher credit quality and better liquidity during economic slowdowns, making it a potential hedge against uncertainty.
Commercial Real Estate Market faces loan maturities and investment opportunities: The commercial real estate market is facing a significant wall of loan maturities, with almost $1 trillion in aggregate loans maturing by year-end 2024. This situation could create problems for property owners who may struggle to find reasonable financing in today's tight credit market. However, it could also present an investment opportunity for private real estate debt managers, as private investors may be needed to provide debt financing in the current lending market conditions.
S&P 500 Equal Weight, Russell 2000 Small-cap & MSCI Emerging Market indices may face resistance: Despite improving technical profiles and higher lows established in March, these indices are currently testing resistance levels at their February highs. A brief pause is likely in the short term, but beyond that, they are expected to continue strengthening through 2023, indicating participation broadening across equity markets.
Cyclical sectors, particularly Industrial and Energy, are expected to continue strengthening: The S&P Industrial sector has rallied above its 2022-2023 high, and the S&P 500 E&P index is showing signs of bottoming and turning higher from important support. This technical behavior suggests that cyclical sectors may continue to strengthen through 2023 into 2024, indicating potential economic strength during that period.
US 10-year yields are within a narrow trading range, remaining a net positive for equities: The US 10-year yields are still in a sideways trading pattern, which is viewed as neutral for equities and supportive of the overall market. However, a move above 4.09% would signal potential inflation pressures, which could be a yellow flag for equities. On the other hand, a decline below certain levels, particularly 3.6% and 3.24%, could indicate concerns about economic weakness.
The Federal Reserve's rate hike cycle is likely over: The data suggests that the rate hike cycle has likely come to an end, with little indication of further rate increases in the near term. The strong economic growth without significant inflationary pressures supports the idea that the Fed may not proceed with further rate hikes.
Fixed income investors can benefit from the current environment: The outlook for fixed income investors remains positive, with short-term yields at their highest levels in nearly 20 years, and longer-term yields still above average. With the Fed on hold, investors have time to put money to work, and it is suggested to consider gradually rolling maturing short-dated bonds into longer-dated bonds to lock in yields for longer and potentially benefit from capital appreciation if yields fall.
US stocks and economic growth remain resilient: Despite concerns about higher interest rates and leading economic indicators flashing cautionary signals, US stocks have posted new 15-month highs, and corporate results have surprised to the upside. The strong showing of the US economy, with GDP growth outpacing expectations, has reduced the likelihood of a recession this year.
The European Central Bank's interest rate hike may see a policy pause: While the ECB has delivered on its interest rate hike promise, the near-term outlook for the eurozone economy has deteriorated. Economic activity indicators have fallen below expectations, and credit supply and demand continue to decline. The ECB remains data-dependent, and there's a possibility of another hike, but not necessarily at the September meeting.
Investor sentiment towards Asian equities has been boosted by China's dovish tone: China's top leadership acknowledges economic recovery challenges and plans to announce more countercyclical policies to boost demand and support economic development. Investors are particularly interested in property market policies and specific announcements of easing measures in H2 2023 to sustain the rally in Chinese equities.
S&P 500 Uptrend: The S&P 500 remains in a notable uptrend since the October 2022 lows, and the market message has improved over the past week. Momentum is overshadowing concerns about further economic softening, leading to a positive tone in the market.
Market Rotation: There has been rotation in the market during earnings season, with a preference towards out-of-favor areas such as Health Care, driven by low expectations and attractive valuations. On the other hand, in-favor areas like Communication Services, with elevated expectations and stretched valuations, are seeing some relative performance give-back.
Federal Reserve (FOMC) Decision: The Fed raised the target rate by 25 bps, and the market seems to have taken it in stride. The market's implied expectation suggests that this rate hike might be the last before the Fed starts to loosen monetary policy, supporting the belief in a potential "soft landing" as inflation data continues to moderate.
Broadening in Breadth: There are signals of better participation in the market as divergences continue to wane. The breadth has improved for the S&P 500, and the Transports sector is showing strong performance following a recent breakout, supporting a more bullish posture.
Actionable Sectors: The Energy sector looks actionable in the short-term, with a recent technical breakout. While relative performance has been lagging, the breakout in absolute price could lead to catch-up in relative performance for the sector.
U.S. Dollar and Emerging Markets: The U.S. dollar is bouncing back to resistance in the short-term. If this is a short-term bounce and not a sustainable move, investors may use it as an opportunity to accumulate Emerging Markets (excluding China), as historically, there has been an inverse correlation between the U.S. Dollar and the relative performance of Emerging Markets.
End of Fed Hiking Cycle: The end of the Fed's hiking cycle appears to be nearing, and the market does not expect any further rate hikes for the remainder of the year, assuming a hike occurs this week. This suggests that the Fed may pause or halt its rate increase campaign in response to economic conditions.
Market Outlook for Rate Cuts: The market seems pessimistic about the outlook for rate cuts, with only one full cut expected in 1Q24 and a cumulative 125 bps of cuts for the year. However, history shows that when the Fed starts cutting rates, it often does so more aggressively, with rates falling on average 275 bps within the first year of cuts. This could mean that the market's expectations for rate cuts may be too conservative.
Investment Climate and Fixed Income Duration: As rates move lower, the investment climate becomes more appealing for all long-term asset classes. Investors may want to consider extending fixed income duration, anticipating that policy rates in 2024 and 2025 may not be as high as currently expected due to a softening in growth momentum and a rapid decline in inflation.
U.S.: Dow Jones Industrial Average: The Dow recorded its longest winning streak since 1987, indicating a positive sentiment in the market. However, trading was relatively subdued during the week due to the summer vacation season diverting attention from important data releases, the Federal Reserve policy meeting, and corporate earnings reports. The week's data also suggests that the U.S. economy might manage a soft landing and avoid a recession despite increasing borrowing costs. Positive economic readings, particularly on inflation, and growth in various sectors indicate a favorable economic environment. The Federal Reserve raised the target rate by 0.25% and signaled a relatively benign tone in its official statement, leading to expectations that the Fed might be done raising rates for the year. Futures markets are pricing in a low probability of further rate hikes by the end of the year.
Europe: European Central Bank (ECB) Interest Rate Increase: The ECB raised interest rates to a record-equaling high of 3.75%, but policymakers hinted at a potential pause in monetary tightening, considering future rate decisions. Spain faces a period of near-term uncertainty due to an inconclusive election outcome, leading to parties jockeying to form a majority coalition government or face another election. Eurozone business activity showed a slowdown, with the Flash Eurozone Composite PMI falling to an eight-month low. Germany's IFO business climate index also fell for the third straight month. In Hungary, the National Bank of Hungary reduced its depo rate and overnight collateralized lending rate, signaling a possible trend of rate cuts.
Asia: In Japan, the BoJ decided to keep its key short-term interest rate unchanged and announced greater flexibility in its yield curve control (YCC) target. The central bank also revised up its forecast for consumer price inflation in fiscal 2023. In China, chinese equities rallied after Beijing signaled it would provide more stimulus to support the economy. The Communist Party's Politburo pledged to boost domestic consumption and enhance support for the real estate sector. Profits at industrial firms in China declined, but at a slower pace than the previous month, indicating ongoing economic challenges and potential deflation risks.
Americas: Inflation in Brazil continues to show modest disinflationary surprises, potentially leading policymakers to consider cutting the Selic rate by 50 basis points rather than 25 basis points.

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