Sentiment Being Tested Even Without a Shutdown
What happened last week?
- The S&P 500 declined by -0.74%
- The Dow Jones dropped by -1.34%
- The Nasdaq ticked up 0.06%
Over the weekend, policymakers reached a deal to avoid a government shutdown until November 17.
But investors are still wrestling with a UAW strike and the resumption of student loan payments, on top of high energy prices and interest rates.
According to the American Association of Individual Investors (AAII), the rise in bullish sentiment that developed when US regional banks stopped failing and the debt ceiling showdown in the spring was resolved has been unwound.
The S&P 500 is 10.6% off its all-time high from January 3, 2022.
3 Things to Know
Potential Returns on the Horizon despite the Warnings
Investors have been stunned with dire warnings of endless inflation and a return to 1970s-style labor unrest. This reminds us of the overwhelming consensus view that a Fed-driven recession was inevitable, leading to 2022 and its rare, combined equity and bond market losses.
Oil prices have risen by 10% in September alone. The shift higher in energy costs at a time of rising rates means energy expenditures will displace other consumer purchases. The jump in fuel prices arrested an earlier rebound in consumer sentiment that was based on falling inflation.
Comparative market dynamics also impact equities. Contradictory data has generated a wider range of possible outcomes for interest rates.
When investors in other asset classes cannot determine where yields will eventually settle, valuations become harder to determine. In short, “yield uncertainty” has contributed to an equity market slide.
We remind investors that after 1931 and 1969, when both asset classes fell together, strong returns were earned by patient investors just two years later.
Equities’ Momentum Broken
The Fed doubled its forecast for US GDP growth in 2023 and raised its growth forecast for 2024 to 1.5% from 1.1%. It also reaffirmed its forecast for lower inflation over time. The impact of projected higher growth was a smaller estimated rise in unemployment, leading FOMC members to forecast smaller rate cuts over the coming two years.
To summarize: “Higher for longer”, a headline markets did not like. This accelerated equity market declines with the S&P 500 down about 7% since July after rising 19.5% in the first half 2023.
The Citi View: 2024 May Offer Stronger Returns
The question on everyone’s mind is “When?”. While we do not know a date and time, we do know that just as rates surged higher this past week, they are likely to decline faster once labor markets and wages cool.
The yield curve is likely to initially flatten for a short period on negative labor market news. Ultimately, however, the yield curve will steepen as the Fed brings down short-term interest rates.
Two-year note yields, for example, will price in more cuts through 2025 than the Fed initially delivers.
What does this mean for investors?
We believe intermediate securities held to maturity will deliver solid returns with greater assurance. We would suggest investors consider adding intermediate investment grade debt.
While the issuers have more credit risk than IG-rated issuers, high yield (HY) bonds with a BB-rating for suitable investors might also be worth considering for higher potential income.
USD-denominated emerging market debt can be an interesting way to take advantage of higher longer-term yields while also earning reasonable compensation for the credit risk of emerging market issuers.
As the equity market is forced to absorb the bond and commodity pressures, some attractively valued growth investments are becoming even more reasonably priced and increasingly worthy of adding to portfolios.
See our weekly CIO Strategy Bulletin for more details