Weekly market insights

Institutional Opinions

1. Disinflation theme: The data indicates a trend of slowing inflation across various categories, which lessens the pressure on central banks to continue hiking interest rates. This suggests that the disinflation theme is likely to continue in the near future.
2. Diversification into lagging equity segments: The recommendation to diversify into lagging segments of the equity market that carry lower valuations indicates that there may be opportunities for investment in undervalued sectors or companies. This suggests that investors may find potential gains by reallocating their investments to these areas.
3. Dollar-cost averaging to take advantage of volatility: The anticipation of higher volatility in the market suggests that investors can benefit from a dollar-cost averaging strategy. By investing systematically at regular intervals, investors can take advantage of potential market fluctuations and potentially achieve better long-term returns.
4. Extending duration within fixed-income portfolios: With the expectation that inflation will continue to decrease and central banks may eventually cut rates, there is an opportunity to extend the duration of fixed-income portfolios. Longer-term bonds with historically high yields may provide income generation and potential capital appreciation if yields start to move lower.
5. Market reaction to inflation and central bank actions: The market reaction to the sharp deceleration in U.S. inflation and the slight shift in expectations regarding central bank tightening suggests that investors are responding positively to these developments. This reaction could continue if inflation continues to cool and central banks pivot towards a pause or rate cuts.
6. Earnings season and market gains: The upcoming earnings season is expected to mark the end of the earnings downturn, with positive growth anticipated in the third quarter and beyond. Positive earnings results could drive further gains in the equity market, although the market's hefty gains in the first half of the year may already be largely priced in.
7. Opportunities in broadening market participation: The recommendation to rebalance and diversify into lagging segments of the equity market suggests that there may be opportunities beyond the dominant mega-cap technology stocks. Value-style investments, small-cap companies, traditional cyclical and defensive sectors, and international stocks are mentioned as potential areas for investment.
8. Impact of higher interest rates and potential economic slowdown: The data suggests that the impact of higher interest rates and a potential economic slowdown may lead to increased volatility in the market. However, historically, strong first halves of the year have been associated with further gains in the remainder of the year. Dollar-cost averaging and diversification strategies are recommended to navigate these potential market conditions.
9. Earnings Outlook: The data suggests that there is pressure building under the surface of higher expected corporate earnings. Profit margins are shrinking, and there is a divergence in earnings forecasts, with tech firms experiencing growth while other sectors stagnate. The outlook indicates that there may be more earnings pain ahead, particularly in the second half of the year.
10. Tight Labor Markets and Profit Margins: The data highlights the tight labor markets in the U.S. and Europe, which could squeeze corporate profit margins. Companies may face pressure to increase wages to attract workers, leading to a potential decline in profit margins. This could result in a challenging macro environment for broad asset class exposures.
11. Central Banks Holding Tight: The data suggests that central banks, such as the Fed, will be forced to keep policy tight to curb inflationary pressures. The market is adjusting to this new regime, and the expectation is that central banks will not quickly ease policy. This indicates a break from the previous era of steady growth and inflation known as the Great Moderation.
12. Granularity and Selective Preferences: The data emphasizes the importance of getting more granular and identifying selective preferences within developed market stocks. Divergence within and across asset classes is expected to be higher in the new regime, offering opportunities for security selection and relative value plays. The focus should be on areas where the macro view is priced in and where mega forces, such as AI, geopolitical changes, low-carbon transition, and financial system evolution, can create shifts in profitability.
13. Impact on Investments: Based on recent data, some investment implications include overweighting short-dated U.S. Treasuries as income becomes a priority, favoring quality in both equities and fixed income, overweighting AI as a multi-country, multi-sector investment cycle unfolds, and considering sectors like healthcare and industrial (particularly automakers) that may be better positioned to navigate the changing macro environment.
14. Market Juncture and Potential Volatility: The surge in government bond yields and the dip in stocks indicate an important market juncture. The data suggests that markets are adjusting to the view that central banks will keep policy tight, and this may lead to increased volatility. The focus will be on whether corporate earnings can meet market expectations during the Q2 reporting season to avoid additional pressure on equities.
15. Full Employment Recessions: The data points to the unusual possibility of "full employment recessions" in the U.S. and Europe, where tight labor markets and worker shortages could result in economic downturns despite low unemployment rates. This unique scenario could have a significant impact on corporate profit margins and the overall macro environment.
16. Yield Curve and Economic Strains: The yield curve has steepened, indicating that the market is pricing in more Federal Reserve tightening and an extended period of higher interest rates. This is likely to keep the yield curve inverted for longer, which could strain the economy and increase the odds of a "hard landing" as inflation proves more challenging to control than anticipated.
17. Forces Shaping Market Direction: As the second half of 2023 begins, several key forces could determine market direction globally. These include the potential for a U.S. recession, additional stimulus measures in China, higher inflation in Europe, a shift in monetary policy in Japan, and a potential breakout in the value of the U.S. dollar.
18. Job Market Outlook: The job gains in the first half of the year were driven by small and medium-sized businesses in the leisure and hospitality industries, as well as strong hiring in the construction sector. However, larger firms, information, and financial services industries have been shedding workers. It is expected that job growth will slow in the second half of the year as firms implement cost-cutting measures to support margins. The Federal Reserve remains concerned about wage growth reinforcing inflation that is still above the 2% target.
19. Investment Implications: Given the outlook for tighter monetary policy, the risk is that the stock market rally in 2023 could fizzle out. As a result, high-quality assets are considered preferable for investors looking to maintain portfolio gains. Valuations in equities have deteriorated since the start of the year, but stronger growth continues to favor U.S. equities. A more cautious view is warranted for international markets, and a focus on diversification, balance, and higher-quality investments is recommended.
20. Yield Curve and Macroeconomic Impact: The shape of the yield curve is seen as an important leading indicator of the economy's direction. An inverted yield curve, where short-term rates are higher than long-term rates, suggests that monetary policy is in a restrictive phase. The longer the yield curve remains inverted, the higher the likelihood of a "hard landing" for the economy. The current deep inversion of the yield curve is a cause for concern, as it has preceded previous recessions.
21. Earnings and Nominal GDP Growth: The data suggests that earnings recession is already underway and is likely to worsen in the coming months. Slowing nominal GDP growth is expected to impact corporate revenue growth, causing earnings to grow less than revenues. The slowdown in nominal GDP growth is attributed to the tightening of monetary policy and the fall in inflation. The earnings recession is expected to be more significant due to the previous stimulus that pushed revenues and margins above their underlying trends.
22. Market Outlook and Valuations: While equity markets had a strong start to the year, valuations have deteriorated compared to a year ago. Expectations for growth have been upgraded, and the U.S. economic activity has not fallen into a recession as initially feared. However, there is a preference for the U.S. market over the rest of the world. Key determinants of market direction in the second half of 2023 include economic and policy developments in the U.S., China, Europe, and Japan.
23. Labor Market Outlook: The labor market has been resilient, with job gains in certain sectors and smaller businesses. However, a weaker labor market is expected to emerge in the second half of the year. Rising layoffs and declining job openings suggest that the unemployment rate will increase. The slowdown in nominal economic growth is expected to drive a continuation of the profit recession and lead to more aggressive cost-cutting initiatives, including labor. This could be a headwind for equity investors in the second half of the year.
24. Equity Market Outlook: The S&P 500 Index has experienced a strong rally in 2023 but is still below its January 2022 peak. The market rally seems extended, with factors such as a deteriorating macro and earnings environment, full valuations, and lack of breadth of gains across the index. A sustainable and broad-based equity rally is expected to take time to develop, and a bumpy and range-bound ride is anticipated in the near term.
25. Commercial Mortgage-Backed Securities (CMBS): The conditions in the commercial real estate space are expected to continue deteriorating, despite resilient economic growth. The Federal Reserve's plan to raise interest rates and keep them higher for longer is likely to contribute to this trend. Credit spreads on CMBS have widened, and rating agencies have started downgrading credit ratings. Higher-quality and short-to-intermediate duration in AAA CMBS sectors are preferred for investors willing to bear the risk.
26. Oil Prices and Russian Supply: Despite political turmoil in Russia, oil prices have remained relatively muted, indicating that the market is shrugging off the risk of a potential supply disruption. Russian oil production has historically been resilient to political and military conflicts. Previous sanctions imposed on Russia's oil industry did not result in a significant decline in oil production. Therefore, a major supply disruption is deemed unlikely in response to the recent military uprising.
27. Private Equity Exit Environment: The economic slowdown and macro headwinds have created a challenging exit environment for private equity funds. The number and value of exits have declined below the long-term trend line. Factors contributing to this decline include a less favorable fundraising environment, declining confidence among corporate leaders, and a tepid IPO market. Private equity managers may opt to extend hold times instead of selling positions below perceived values. This could lead to limited partners selling fund stakes on the secondary market to generate liquidity. However, the slowdown may also present attractive buying opportunities for funds with cash to deploy, particularly in small/mid-cap buyout and growth equity strategies.
28. Equity Market Outlook: The S&P and Nasdaq have reaccelerated their rally following a brief pause. The uptrends for both indexes remain intact, with resistance levels at 14,534 for the Nasdaq and 4,637 for the S&P. A decline below the June lows would be needed to signal a reversal in the uptrends. Participation in the market is broadening beyond mega-cap growth stocks, with cyclicals showing improvement. Industrial, financial, materials, and energy sectors are exhibiting signs of bottoming after pullbacks. As earnings for Q2 are reported, pullbacks are expected to be relatively short-lived, presenting buying opportunities within both secular and cyclical growth groups.
29. US 10-Year Yield: The US 10-year yield reversed from an important upside level of 4.09%, alleviating concerns of a surge in rates. The next important support is at 3.6-3.7%, and a break below that level would suggest further weakness toward the 3.25-3.3% range. This suggests a potential decline in interest rates, which could be a tailwind for equity markets.
30. US Dollar Index (DXY): The US Dollar Index experienced an important technical breakdown, collapsing below a key level at 100.8. The weakness in the US dollar confirms a downtrend that started in Q4 2022. The next support level is near the 62% retracement level at 98.9. A weaker US dollar is seen as a tailwind for equity markets.
31. Broadening Participation: The S&P 500 Equal Weighted, Russell 2000, and MSCI Emerging Market indices are showing signs of broadening participation beyond mega-cap technology stocks. These indices established cycle lows in Q4 2022 and higher lows in March 2023, indicating a positive trend reversal. To confirm a new uptrend, a move above the February highs is needed. The levels to watch are 6,321 for the S&P Equal Weighted index, 2,007 for the Russell 2000 Small-cap Index, and 1,057 for the MSCI Emerging Market index. It is expected that these indices will rally to their February highs and potentially push higher, supported by declining interest rates and a weak US dollar throughout the rest of 2023.
32. Earnings Outlook: The consensus forecast for S&P 500 Q2 earnings is a decline of 7.0% year over year. However, it is anticipated that the actual results will be better than feared, with an estimated decline of around 3.4% after factoring in earnings beats. Sectors such as Energy and Materials are expected to be significant drags on Q2 results due to tough year-over-year comparisons. Excluding these sectors, the consensus forecast projects 1.4% growth, with the potential for higher growth if earnings beats materialize. Technology-oriented stocks and the Industrials sector face higher hurdles to maintain their recent gains, and their performance will be closely monitored for indications of U.S. and global economic trends.
33. Market Stance and Valuation: A Market Weight stance in U.S. equities is deemed appropriate due to economic and earnings growth uncertainties in the near future. Recession risks are still a concern, and the stretched valuation of the S&P 500, with a high P/E ratio and elevated PEG ratio, suggests limited room for economic disappointments. It is prudent to maintain U.S. equity exposure at the long-term recommended level in portfolios.
34. Economic Factors: The Consumer Price Index (CPI) in the United States showed a smaller annual increase, indicating progress on price stability. The data led to a positive reaction in Treasury yields, with a higher probability of a more benign policy stance from the Federal Reserve. However, policymakers may be reluctant to cut rates without multiple months of acceptable core inflation. In Canada, the Bank of Canada (BoC) raised interest rates for a second consecutive time, showing growing concern about inflation risks. The BoC expects excess demand to persist into 2024, leaving the possibility of another rate increase in September.
35. Regional Outlook: In the UK, private sector pay growth remained strong, driven by higher inflation expectations and a tight labor market. The Bank of England (BoE) may opt for another interest rate increase in August, considering high wage growth. European equities have underperformed global equities, but earnings trends have been more resilient. However, there have been divergences in earnings expectations for different sectors, with notable downgrades for the European chemicals sub-sector and continued upgrades for European banks. In Asia Pacific, there has been a risk-on mood toward Asian equities, particularly Chinese stocks, due to improved investor sentiment following regulatory developments. Chinese exports declined significantly, suggesting weak external demand and potential challenges to China's recovery in the second half of the year.
36. Market Momentum: The recent wave of market momentum continues, with equities pushing to year-to-date highs. The wider participation of lagging areas driving performance, rather than just a handful of Tech heavyweights, is a positive sign. Better-than-expected economic data is supporting the recent strength.
37. Economic Outlook: The economy has held up better than expected this year, leading to increased talk of a non-recessionary or soft-landing scenario. The timeline for economic contraction has been pushed out, but there is still a likelihood of a mild recession occurring within the next 6-12 months.
38. Equity Market Outlook: Overall, a positive outlook is maintained, with expectations that equities will reach their prior highs by the end of next year. The bear market that started 18 months ago is following a historical pattern, and leading indicators suggest a decline in inflation ahead. As inflation comes down and/or employment weakens, the Fed may pivot, and equities will begin pricing in the eventual economic recovery.
39. Earnings Season: Some data also suggests that the Q2 earnings season is anticipated to have a higher bar for positive surprises compared to the previous quarter. Economic concerns have eased, and earnings revision trends have slowed their pace of decline. Valuations have extended despite rising bond yields. However, the potential for upside surprises may be lower in Q2, given the higher expectations.
40. Technical Analysis: The S&P 500 index has been riding above its 20-day moving average and broke above resistance levels. The 20-day moving average will be the first level of support to monitor. The MACD is close to rolling over, and stochastics are at overbought levels, indicating a potential consolidation or pullback in the near future. The upcoming earnings season will be an important catalyst to monitor.
41. Participation and Opportunities: Better participation has been observed beneath the surface, indicating a broadening out of market participation. Lagging areas present opportunities for investment. The US dollar's decline following the CPI report could have a positive influence on commodities, Materials, and Energy sectors. Energy remains in an overall downtrend, but its performance may improve if WTI crude oil breaks its downtrend and the US dollar continues to weaken.
42. U.S. Stocks: Stocks in the U.S. recorded strong gains during the week, driven by cooling inflation signals. The S&P 500 and Nasdaq Composite both saw positive performance, with standout performers in sectors such as casino operators, regional banks, and asset managers. The unofficial start of earnings season with major banks reporting second-quarter results also contributed to the positive sentiment.
43. Inflation Data: The release of consumer price index (CPI) inflation data showed a continued cooldown in inflation. Both headline and core inflation rose 0.2% in June, slightly below expectations. The annual increase in headline inflation slowed to 3.0%, its slowest pace since March 2021, while core inflation slowed to 4.8%, the slowest since October 2021. Producer price index (PPI) inflation data was also encouraging, with headline producer prices nearing deflation territory and core producer prices at their slowest pace since January 2021.
44. Consumer Sentiment: The University of Michigan's gauge of current consumer sentiment showed its largest monthly gain since 2006. Consumers reported improved optimism due to better labor market conditions and falling inflation. This data suggests that the economy might be able to avoid a recession and experience a "soft landing" as inflation cools.
45. U.S. Treasury Yields: U.S. Treasury prices rose as longer-term yields retreated following the positive inflation data. The yield on the benchmark 10-year note fell below 4%. Supportive technical conditions remained in the municipal bond market, leading to strong demand for munis.
46. European Stocks: European stocks experienced their biggest weekly gain in about three-and-a-half months. Cooling inflation in the U.S. raised expectations that interest rates may soon peak. China's extension of support measures to the property sector also contributed to optimism. Major stock indexes in France, Germany, Italy, and the UK advanced.
47. ECB Monetary Policy: The minutes of the European Central Bank's (ECB) June meeting showed support for further rate increases amid concerns about persistently high inflation. Policymakers discussed the need to communicate that monetary policy still has more ground to cover to bring inflation back to target. The possibility of interest rate increases beyond July was considered. However, a meeting-by-meeting approach was favored, especially as rates approached a possible peak level.
48. UK Economic Outlook: The UK economy contracted less than expected in May, and wage growth hit a record level. GDP grew on a rolling three-month basis, and wages grew at a record annual pace in the three months through May. However, the labor market showed signs of easing with a slight increase in the jobless rate.
49. UK Housing Market: Surging mortgage rates affected the UK housing market, with homebuyers pulling back at the sharpest pace in eight months. Higher borrowing costs were seen as weighing on affordability.
50. China's Economy: Chinese equities rallied after Beijing announced measures to support the country's economy. The extension of policies to defer property development loans and support project delivery raised hopes for additional economic stimulus. Inflation data showed unchanged CPI and decreasing core inflation, indicating increasing deflation risks and a weakening post-lockdown recovery.
51. Japan's Equities and Monetary Policy: Japanese equities lagged behind other Asian markets. Expectations that the Bank of Japan (BoJ) may adjust its yield curve control framework exerted upward pressure on domestic yields. The yen strengthened against the U.S. dollar, anticipating monetary policy normalization. The 10-year Japanese government bond (JGB) yield rose, nearing the BoJ's cap level.
52. EU-Japan Summit: Japan and the European Union agreed to boost strategic cooperation on digital and critical raw materials supply chains. Restrictions on food imports from Fukushima were lifted, providing support for the affected area's reconstruction.
53. Brazil and Colombia: In Brazil, inflation remained below the central bank's key policy rate, and there were signs of cooling in core goods price pressures. The central bank is expected to start reducing the policy rate in the next couple of months. In Colombia, inflation showed a slight decrease, mainly led by food prices. Core inflation and services inflation also showed signs of easing, but the central bank is not yet expected to begin an easing cycle.
54. Labor Market Momentum: The labor market in the U.S. has shown resilience in the first half of 2023, supported by strength in the labor market and consumption. However, the labor market momentum appears to be cooling, as indicated by various key indicators. This suggests that the pace of growth in the labor market may slow down.
55. JOLTS Job Openings: JOLTS job openings fell to 9.8 million, bringing the ratio of openings to unemployed workers to its lowest level since October 2021. This indicates a decline in the number of available job opportunities, which may contribute to a slowdown in the labor market.
56. Quits-to-Layoffs Ratio: The quits-to-layoffs ratio rose, driven by increasing quits. Although still elevated, it is 23% below last year's peak. This suggests that workers are more confident in leaving their current jobs, potentially seeking better opportunities. However, a higher quits-to-layoffs ratio also indicates potential challenges for employers in retaining talent.
57. Nonfarm Payrolls: Nonfarm payrolls rose by 209,000 in June, falling short of expectations and showing a slowdown compared to May. This slower pace of job growth, along with downward revisions to job growth in previous months, confirms the fading momentum in the labor market.
58. Unemployment Rate and Wage Growth: The unemployment rate ticked down to 3.6%, indicating continued strength in the labor market. Wage growth also ticked up to 4.4%, highlighting the ongoing strength in wages. However, slower job growth may lead to slower wage growth in the future as labor demand cools.
59. Impact on Fed Policy: The increasingly balanced labor market, with slower wage growth, may reduce pressure on the Federal Reserve (Fed) to maintain its hawkish messaging and tighten monetary policy aggressively. Slower wage growth should also allow inflation to drift lower, aligning with the Fed's goal of maintaining price stability.
60. Expectations for the July FOMC Meeting: The data did not significantly change expectations for the July Federal Open Market Committee (FOMC) meeting. The Fed may take note of the cooling labor market momentum but could maintain its current stance on monetary policy.

Previous update:

Institutional Opinions

1. Central bank actions: The Federal Reserve and the Bank of Canada are expected to raise interest rates in July. After the rate hikes, the central banks are likely to remain data-dependent and may lean towards an extended pause in rate hikes thereafter. There is also a possibility of rate cuts in the future.
2. Labour market: The labour market has been resilient and supportive of economic growth, but there are some signs of softening emerging. While the labour market is expected to remain relatively healthy in the near term, there may be some easing and slowing in the months ahead, especially if services demand cools.
3. Inflation: Leading indicators of inflation, such as wage growth and prices-paid components of manufacturing and services data, suggest a cooling in inflation. Inflation is expected to moderate further, potentially bringing headline inflation down to around 3.0% by year-end.
4. Market implications: The expectation of higher interest rates for a longer period has led to upward pressure on bond yields. Treasury yields and Canadian government bond yields have climbed higher, putting downward pressure on bond prices. Stock markets have also experienced some downside as higher discount rates impact valuations.
5. Economic growth: The services sector has shown relative strength and expansion, contributing to economic growth. However, there are indications of softness in the manufacturing sector. The overall economic growth may slow to below trend in the back half of 2023, but a traditional recession or downturn may be avoided as certain segments of the economy may start to recover.
6. Market recovery: Looking towards 2024, there is a possibility of a better backdrop for inflation, central banks pausing rate hikes, and potentially contemplating rate cuts. This, along with emerging opportunities in equities and bonds, suggests the potential for a broader and more sustainable market recovery in the future.
7. Stocks: The U.S. stock market experienced a decline during the week due to a generally quiet trading environment and investors awaiting the release of second-quarter earnings reports. Growth stocks performed slightly better than value shares. The market may continue to be influenced by earnings reports and investor sentiment.
8. Federal Reserve: The release of the minutes from the Federal Reserve's last policy meeting revealed a hawkish outlook among some members, indicating a preference for another rate increase. This has led to expectations of two more rate increases in the remainder of the year. The market will continue to closely monitor Fed communication and economic data for clues about future rate hikes.
9. Job market: The job market showed signs of a slowdown in the U.S., with nonfarm job additions in June falling slightly below expectations and the lowest number since December 2020. The unemployment rate edged down, but there was an increase in the number of people employed part-time for economic reasons. The job market data will be closely watched for its impact on the overall economic outlook.
10. Monetary policy: Fears of central banks tightening monetary policy led to a decline in European stock markets. Investors were also disappointed by the lack of specific measures to boost the Chinese economy. Bond yields in Germany, France, and Italy ticked higher. The market will closely follow central bank actions and economic indicators for further guidance.
11. Economic weakness: German data pointed to continuing economic weakness in the second quarter, with industrial production, factory orders, and exports showing signs of decline. Eurozone industry price pressures eased, and retail sales remained weak. The economic indicators will be monitored for any signs of improvement or further weakness.
12. Stock market: Japanese stock markets fell during the week, retreating from 33-year highs as investors locked in profits, particularly in technology stocks. The markets were also influenced by anticipation of potential interest rate hikes by the U.S. Federal Reserve. The Bank of Japan's accommodative monetary policy and weak yen helped cushion losses.
13. Monetary policy: Speculation that the Bank of Japan (BoJ) could adjust its policy of yield curve control led to an increase in domestic yields. However, BoJ Deputy Governor Shinichi Uchida stated that the central bank will maintain its yield curve policy. The BoJ's approach to monetary policy will be closely monitored for any changes.
14. Equities: Chinese equities retreated as economic data raised concerns about the country's post-pandemic recovery. The private Caixin survey of manufacturing activity indicated a softening in manufacturing output and new orders. The weak data were in line with the official Manufacturing Purchasing Managers' Index, which contracted for a third consecutive month.
15. Economic policies: Chinese Premier Li Qiang pledged to implement targeted policies to strengthen China's post-pandemic recovery. The market will closely watch for specific measures and their potential impact on the economy.
16. Monetary policy: The central banks of Chile and Mexico released the minutes from their respective policy meetings. In Chile, policymakers are on the verge of beginning a rate-cutting cycle, while in Mexico, the key rate was left unchanged with an expectation of maintaining it at the current level for an extended period. The central banks' future actions will depend on economic conditions and inflation outlooks.
17. Equity market performance: The S&P 500 index has shown strong performance in the first half of the year, with a 15.9% year-to-date return. However, performance has been driven primarily by tech-oriented areas, while the average S&P 500 stock excluding tech has only gained 5% year-to-date. Participation in the market will need to broaden out for the current uptrend to develop into a healthy bull market.
18. Economic outlook: The economy has held up better than expected, supported by unique factors such as undersupply of labor and government stimulus. However, leading economic indicators and the yield curve are at levels historically consistent with a recession. The odds favor a mild recession occurring later in the year. Economic volatility may impact market volatility, and economic reports will carry weight in determining the trend.
19. Earnings season: Earnings season will begin in two weeks, with the major banks kicking things off. Expectations for Q2 earnings are higher compared to Q1, and the bar has been raised. Positive surprises buoyed equity markets in the past, but Q2 may not provide the same upside surprise given better expectations and recent performance.
20. Interest rates: Interest rates, such as the 2-year Treasury yield and the US 10-year Treasury yield, are approaching highs. Equity markets have looked past recent increases in rates, but if bond yields continue to show upside, it may impact equity valuations and require downward adjustments.
21. Technical analysis: The S&P 500 index has continued its uptrend since the October lows, but there may be a need for market volatility due to economic realities. Potential support levels to watch include the 20-day moving average, 50-day moving average, and 200-day moving average.
22. Sector performance: The Technology sector has shown significant outperformance, with a 42% gain in the first half of the year. However, such outperformance may indicate a cooling-off period in the sector. Signs of potential improvement can be seen in the S&P 500 equal-weight index and small caps, but further observation is needed.
23. Fed's balance sheet: The Fed's balance sheet has influenced equity market returns since the 2008 credit crisis. Currently, as the Fed fights high inflation, liquidity is being drained from the system, which can be a headwind to inflation (positive) and economic growth (negative).
24. Duration strategy: The advice for fixed-income investors is to consider buying longer-maturity bonds at current interest rate levels, as longer-term rates are believed to be near their peak. This strategy aims to take advantage of attractive yields and lock in longer-term interest rates, especially for long-term investors prioritizing income.
25. Defensive portfolio strategy: As part of a defensive portfolio approach, decreasing exposure to equities overall and allocating some funds to short-term fixed-income securities is recommended. The attractive yields on Treasury securities with 3-month, 6-month, and 12-month maturities provide an opportunity to wait out anticipated increased downside volatility in the equity market. This approach allows sidelined funds to be put to work during periods of market volatility.
26. Interest rate scenarios: Over the next 6-18 months, several interest rate scenarios are anticipated. In the near term, short-term interest rates could move slightly higher as the Federal Reserve continues efforts to manage inflation. However, a potential scenario is that rates would eventually move lower as the economy slows and enters a recessionary period, accompanied by a decrease in inflation. During this time, both longer-term and shorter-term rates typically ease. Finally, at some point, likely next year, financial markets could anticipate an economic recovery, leading to somewhat higher rates again.
27. Ebb and flow of interest rates: The ebb and flow of interest rates and the fixed-income market in the coming quarters are expected to provide opportunities for investors. Increasing duration and utilizing funds from short-term instruments during downside volatility in stocks are strategies that can be beneficial.
28. Stock market performance: The U.S. large-cap stocks led the way in the first half of 2023, with a 15.5% increase. However, this performance has been driven primarily by the market's largest stocks, indicating a narrow breadth in the market. U.S. small-cap stocks have lagged behind due to lower-quality earnings and greater exposure to underperforming cyclical sectors.
29. International market performance: Developed markets (DM) and emerging markets (EM) experienced increases of 11.2% and 4.8%, respectively, in the first half of 2023. A weaker U.S. dollar and strong economic data in both regions contributed to these returns. However, EM momentum weakened toward the end of the quarter, partially due to disappointing economic data from China.
30. Fixed income performance: U.S. fixed income increased by 1.8% in the first half of 2023, driven by a moderation in interest rates. Global high-yield bonds performed well, supported by better-than-expected earnings and relatively favorable credit quality. While default rates and downgrades-to-upgrades have increased, they remain below long-term averages.
31. Factors impacting markets: Looking ahead, investors should remain active and diversified. The stock market's narrow breadth, weakening expectations for forward earnings, and the possibility of further interest rate hikes from the Federal Reserve could weigh on markets in the coming quarters. It is important to monitor these factors and adjust investment strategies accordingly.
32. Equity markets: The equity rally that started in Q2 appears to have peaked and markets are experiencing a pullback. Both the Nasdaq and S&P are showing signs of stalling under resistance levels. This pullback is viewed as a healthy pause within a longer-term cycle recovery, and it is expected to be short-lived in Q3, presenting an opportunity to broaden equity exposure.
33. Short-term levels: The S&P has resistance around the 4,500 range, while the Nasdaq faces resistance near 13,873. Support levels for the S&P are around 4,300 and 4,155-4,200, while the Nasdaq has support around 13,150 and 12,427. Based on the longer-term technical profiles, it is unlikely that both markets will correct below their lower support bands.
34. US 10-year yields: The US 10-year yield has broken out above a key level at 3.9% and further interest rate hikes by the Federal Reserve are anticipated to fight inflation. The next key upside level is at 4.09%, and a move above that level could indicate further upside towards the 4.25-4.33% range, which may have a negative impact on equity markets. On the downside, 3.8-3.9% is a key level to watch. It is expected that upside momentum will likely be capped at the 4.24-4.33% band, potentially coinciding with equity markets moving towards oversold levels and their next key support levels.
35. Tight monetary policy: Major central banks, including the Federal Reserve and the European Central Bank, are expected to keep policy tight in response to persistent inflation and supply constraints. This tight policy environment is likely to impact broad asset class returns and create challenges for economic growth.
36. Income-focused investments: The appeal of income is expected to increase in the current macro regime. Short-dated government bonds, such as three-month U.S. Treasury bills, may become more attractive due to higher yields. The case for short-term government paper is bolstered by the expectation of tight policy rates.
37. Granular investment approach: To navigate the current market environment, investors should consider getting granular within asset classes, regions, and sectors. There are different and abundant opportunities available, and a focus on security selection, expertise, and skill will be important for achieving above-benchmark returns. Quality assets in both equities and fixed income are favored.
38. Mega forces: Structural shifts driven by mega forces such as digital disruption (e.g., artificial intelligence), geopolitical fragmentation, the low-carbon transition, aging populations, and the future of finance are expected to shape profitability across economies and sectors. Investors should identify the likely beneficiaries of these mega forces and assess whether the potential effects are priced into the market.
39. Potential volatility and market mispricings: Greater volatility and dispersion within and across asset classes are anticipated in the new macro regime. This can create more opportunities for uncorrelated exposures, relative value trades, and security selection. Expertise and skill in identifying market mispricings will be crucial for generating returns.
40. Strength of the U.S. economy: The U.S. economy is described as competitive, resilient, and one of the most dynamic economies in the world. It has maintained its share of total world output despite major seismic events over the past forty years. Betting against the U.S. has been costly for investors, as U.S. equities have outperformed global indexes over the past decade.
41. Long-term investment in the U.S.: Investors are advised to lean against the perception of American decline and instead focus on the long-term potential of the U.S. economy. The narrative of American declinism may lead to investment paralysis and hinder long-term investment returns. The recommendation is to stay invested in U.S.-denominated assets.
42. Diversification and balance: The investment view emphasizes diversification, balance, and a focus on higher-quality investments. Opportunities to add to equities for long-term exposure may arise, and a solid mix of growth and value investments, small- and large-capitalization stocks, and higher-grade bonds across multiple sectors is recommended.
43. Attractiveness of the U.S. for foreign capital: The U.S. remains a magnet for foreign capital, both in terms of portfolio flows and foreign direct investment (FDI). Foreign investors have shown confidence in the U.S. market, supporting the U.S. dollar as the world's reserve currency. The U.S. attracts more FDI than any other economy, thanks to its transparent, market-friendly environment.
44. U.S. as a global manufacturing and trading superpower: The U.S. is described as a global manufacturing superpower, leading in multiple manufacturing categories. It is also a major exporter of goods and services, with a record high of $3 trillion in exports in 2022. America's global brand presence is strong, and its universities are leaders in producing skilled and productive capital.
45. U.S. as a technology leader: Despite China's technological advancements, the U.S. remains the world's technology leader. The U.S. market is the largest for information technology spending, e-commerce, and the digital economy. The country's focus on research and development and its entrepreneurial culture support its competitive edge in technology and innovation.
46. Long-term bullish outlook for the U.S.: Overall, the data and analysis presented suggest a bullish outlook for the U.S. economy. Despite challenges that need addressing, the U.S. is positioned to remain one of the most competitive economies in the world. Investors are advised to focus on the long-term potential of the U.S., stay invested in U.S.-denominated assets, and not be swayed by short-term market fluctuations or negative narratives about American decline.