Mixed Week on Wall Street
What happened last week?
- The S&P 500 down 0.3%
- The Dow Jones was up 0.6%
- The Nasdaq was off by 1.9%
This week the market will focus on US housing data and leading economic indicators (LEI). Data on building permits and housing starts will be watched for signs that home construction is stabilizing as the Fed tightening campaign winds down. LEI are expected to be negative for the 16th month in a row.
We expect some industries to weaken while others strengthen in 2023–2024 in a rolling fashion due to a myriad of supply-demand peculiarities and circumstances that have taken place in recent years.
With yields high and inflation set to come down further, we see opportunities in fixed income.
3 Things to Know
A Rates Trifecta
The possibility of a more proactive Fed resulted in a very sharp jump in long-term yields over the past two weeks.
- 10- and 30-year yields rose 30-40bps before trading at 4.12% and 4.25%, respectively, late last week.
- Macro data is showing that US real GDP remains above 2%, wages are still growing at around 5% and unemployment is historically low.
- Even deeply impacted industries such as homebuilding have been experiencing a modest resurgence.
Consumers are also purchasing services such as travel and leisure, too. Thus, for longer-term bond holders an extra premium known as a “term premium” has been priced into account for this stronger-than-expected economy.
But there are other factors too.
Firstly, two days after July’s FOMC meeting, Japan announced that it would permit their government bond yields to rise, from 0.5% to as high as 1%. This caused yields to move higher globally. As Japanese rates move up, their demand for US Treasuries is likely to fall.
Secondly, the US Treasury also indicated huge future bond sales were on the horizon for the third quarter, some US$1 Trillion in new issuance with the Fed allowing US$180 billion to roll-off of their balance sheet at the same time.
Finally, the US-based rating agency Fitch downgraded US Treasury ratings from AAA to AA+. S&P did the same in 2011. Fitch’s action refocused market attention on the growing size of the US total public debt as well as the rate of its growth.
Despite all this news, we think the recent move higher in longer-term yields is unlikely to be sustained.
Peak Rates?
Fed chair Jerome Powell’s recent comments appeared to suggest that the FOMC would not wait until it reaches 2% before they begin cutting rates. This halted the rise in yields at the front end of the curve. Paradoxically, higher long-term yields will likely accelerate the decline of inflation.
If so, the Fed is more likely to cut rates in 2024.
If the Fed is finished hiking rates, based on the tone of its recent message, the next Fed move months from now is more likely to be a reduction.
This means that Treasury notes with maturities of six months to five years are unlikely to provide higher yields, especially if inflation shifts lower into 2024.
To avoid reinvestment risk and a decline in short term yields, our view is that investors clients consider maintaining a portfolio weighted toward intermediate bonds.
The Equities Rally Has Broadened
Our Mid-Year Outlook released in June highlighted just how concentrated this year’s equity rally has been.
As we observed at the end of May, of the US$4 trillion rise in market value in 2023, 89% could be attributed to just ten companies, mostly US mega-cap tech names.
In the two months since, US equities are up 7% but participation has broadened out. The Russell 2000 Small Cap index has rallied 10% and the average S&P 500 firm is nearly 8% higher.
Almost 60% of public equities are trading above their 200-day moving average, up from 12% in late 2022.
But even after a few strong months, high quality small and mid-sized firms remain 15% below all-time highs. Large cap stocks are down just 7%.
See our weekly CIO Strategy Bulletin for more details