If rising yields were the story in financial markets through most of the year, then November brought a sharp reversal in what we had been seeing for several quarters now.
Throughout the year, sovereign yields in the US had moved steadily upward. One popular narrative that market participants used to explain the move higher in yields was the idea that the market had moved to price in a “higher-for-longer” scenario, whereby the Federal Reserve balanced its stated desire to fight inflationary pressures with a still strong US economy. The resilience of the latter would enable the Fed to keep rates at an elevated level in order to ensure that inflation was durably returned to target levels.
This narrative seems to have vanished in favor of a soft landing for the US economy, accompanied by several benign rate cuts in the back half of 2024. This is largely the result of the continued deceleration in core CPI in the US, driven by the ongoing decline in the shelter component. Going into the month of November, rate markets were pricing the first cut from the Fed in June 2024 and a total of three cuts on the year. Expectations for the first cut have now been pulled forward to May 2024 and the market is pricing in nearly two additional cuts in the back half of the year.
This repricing has also come at a time when economic growth continues to show incredible resiliency. As a result, expectations for corporate earnings growth in 2024 remain well into the double digits.
Set against this backdrop of declining sovereign yields and a resilient economy, US equity markets delivered positive returns: the S&P 500, Dow Jones Industrial, and Nasdaq Composite were up 8.9%, 8.8%, and 10.7%, respectively. Moving forward, we continue to maintain a cautious approach. Historically speaking, soft landings are incredibly rare, particularly when inflation rates are coming down from the levels they currently are and the Fed has acted as aggressively as it has. It is important to remember that calls for a soft landing have always been the loudest just prior to the onset of periods of economic weakness.
We have been adamant that a soft landing is unlikely as we progress through the economic cycle. Historical evidence suggests that the Fed has never brought inflation down from the levels we’ve seen without causing significant economic hardship.
Should the Fed begin cutting rates next year, we believe it is more likely than not that it will be in response to an adverse economic outcome, and therefore, we would anticipate the Fed would have to cut more aggressively than the market is currently pricing. Moreover, earnings would likely be hit hard by the economic slowdown driving the Fed to cut.
Given this, the market is likely going to have to reprice its outlook with higher yields, rising uncertainties, and weaker earnings. While the market is typically forward-looking, recessions tend not to be priced into the market until their arrival is imminent.
With that in mind, we are placing an emphasis on risk management and have adopted a defensive position strategy in our core portfolios.
Ozempic: Opportunity or Over-Hyped?
After more than five years of being on the market, Ozempic is changing the landscape of GLP-1 drugs, but not for diabetes – for weight loss.
Now, with the potential to treat obesity in addition to diabetes, Ozempic provides life-changing opportunity for both diabetic and weight loss patients. However, does it provide the same opportunity for investors?
We share our thoughts and analysis in our latest article, Opportunity or Over-Hyped: The Trend of GLP-1 Drugs Like Ozempic.
|The economy is in a late cycle. The Fed has hiked aggressively and while the economy has remained resilient to date, the manufacturing industry is showing serious pain, and we anticipate that the lagged effect of monetary policy will start to be felt in other parts of the economy in the coming quarters.
|The US stock market has rebounded strongly off its October 2022 lows. Sentiment now appears stretched and valuations are not compelling. To date, market returns have been driven by multiple expansions. EBIT margins climbed to historical highs in the years following COVID lockdowns; elevated input costs and weakening demand and pricing power are posing a risk to the ability of corporations to maintain earnings at their projected level. Returns will be harder to come by and stock selection will be increasingly important.
|Interest rates remain well off their lows, as the economy has remained resilient, and the market is weighing the dynamics of still-elevated core inflation and the potential for interest rates to remain higher for longer. Corporate spreads remain well contained, particularly considering the risks we see to the economy.
|Important Issues on the Radar
|Inflation: Factors including a resilient demand environment and wage increases threaten to keep core inflation elevated. Should this be the case, the Fed may remain tighter for longer.
|China’s Economy: China has pivoted on the two key economic issues that acted as severe headwinds to growth over the last two years; however, economic growth appears to be stagnating and it will be critical to monitor the policy response in the coming months.
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Source: Wall Street Journal. Bloomberg.
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