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Weekly Commentary
Oasis or mirage? Equities ponder the economic horizon
Bottom line up top:
- What investors think they see might not be what they get. Against a macro backdrop that continues to fluctuate between marginally negative and incrementally positive, some investors may be positioning too soon for greener pastures, considering the still-challenging equities environment that’s likely to persist into 2023.
- U.S. Federal Reserve Board Chair Jerome Powell’s speech at the Brookings Institution last week signaled a deceleration in rate hikes, perhaps as early as this month. U.S. equities reacted exuberantly to Powell’s comments, with the S&P 500 Index jumping 3% on the day, similar to what we’ve seen in this year’s previous bear market rallies. But even if Powell’s projection comes to pass, there’s no clarity on the timing of the path down from a terminal rate that’s largely expected to reach 5% by May 2023.
- The S&P 500 has struggled to climb out of the bear’s den on several occasions since falling into it back in June, but each attempt has been thwarted by the stark realization that the Fed’s war on inflation is far from over.
- Inflation remains unacceptably high even as some disinflationary pressures appear to be taking hold.
- The U.S. labor market is showing signs of loosening — evidenced by a decrease in job openings per the latest JOLTS survey and a slow but steady rise in weekly unemployment claims. However, conditions still look tight overall, made clear by Friday’s release of stronger-than expected job and wage growth data for November.
- While still positive, U.S. economic growth has slowed on an annualized basis. As of 1 December, the Federal Reserve Bank of Atlanta’s GDPNow tracker pegged Q422 annualized growth at 2.8%, down from a pre-Thanksgiving 4.3%. This is not an “official” estimate, but the Atlanta Fed’s model has proven fairly reliable at tracking growth in real time as various economic data points come in.
- The bear tracks aren’t moving in a definitive direction. Nuveen created a Bear Tracker model in July to help assess when an end to the U.S. equity bear market may be imminent. The tracker monitors six key factors that have frequently shown inflection points near the bottom of past bear markets: valuations, earnings, Fed policy, manufacturing activity, market breadth and bond spreads. Based on our tracker readings (see figure below) and in the context of recent Fed rhetoric and market behavior, it’s difficult to declare with certainty whether U.S. equities have already hit bottom or may stumble further before finding the strength and stamina to outrun the bear at last. In the meantime, we think that the market is likely to be range-bound, with relative dips and rallies in the near- to medium-term as uncertainties continue to manifest heading into 2023.
- Earnings estimates for next year look unrealistic. Bear-market bottom or not, the forecasted earnings growth rate for 2023 is still positive, currently exceeding 5%. In our view, this doesn’t accurately reflect the difficulties that lie ahead for equities as elevated interest rates continue to slow economic growth. Downward revisions to earnings estimates from here may spell an end to the recent resilience of equity markets.
Downward revisions to earnings estimates from here may spell an end to the recent resilience of equity markets.
Portfolio considerations
Our base case calls for a continued deceleration of inflation through the first half of next year, although it should remain elevated and well above the Fed’s 2% target. Price disinflation is likely to translate into lower corporate revenues, sparking another possible leg down for equities. Our preference for quality and dividend growth stocks reflects this scenario. We also suggest reducing cyclicality by increasing exposure to infrastructure, which is often capable of growth through economic slowdowns thanks in part to inelastic demand for the necessary services these businesses typically provide.
Additionally, with the bulk of interest rate hikes behind us, we think it makes sense to modestly increase duration through bolstering core bond allocations. We specifically like investment grade credit, which is yielding above 5%. This should provide a cushion against any spread widening that may come as we potentially enter a mild recession next year. We also remain favorable on municipal bonds; they look particularly undervalued given strong fundamentals.
With the bulk of interest rate hikes behind us, we think it makes sense to modestly increase duration through bolstering core bond allocations.
Nuveen’s Global Investment Committee (GIC) brings together the most senior investors from across our platform of core and specialist capabilities, including all public and private markets.
Regular meetings of the GIC lead to published outlooks that offer:
- macro and asset class views that gain consensus among our investors
- insights from thematic “deep dive” discussions by the GIC and guest experts (markets, risk, geopolitics, demographics, etc.)
- guidance on how to turn our insights into action via regular commentary and communications
Related articles
Access previous issues of Saira Malik’s weekly CIO commentary on strategy and portfolio construction.
U.S. Treasury yields fell sharply after U.S. Federal Reserve Chair Powell stated that he did not want to “overtighten,” supporting fixed income returns. Separately, economic data was mixed.
Brian Nick discusses that Fed rate hikes will continue until inflation improves in the November Fed meeting
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Endnotes
Sources
All market and economic data from Bloomberg, FactSet and Morningstar.
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