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When history rhymes…
In the not-too-distant past, when Alan Greenspan was still playing the Sphynx at the Federal Reserve, the Fed model was very much in vogue. Younger readers who have only been following the markets for a couple of decades may be unfamiliar with this partially obsolete concept. The idea behind the Fed model was to compare the S&P500 earnings yield* with the US 10-year yield. This provided an indication of the relative attractiveness of one asset class versus another. When 10-year yields are higher than earnings yields, bonds are more attractive than equities; when they are lower than earnings yields, equities should be preferred. In the short term, the crossover between earning yields and 10-year yields surely sends a cautious message: US equities have gone a little too fast compared with fixed income and we could see a return to the mean. It also reflects the fact that the S&P500 behaved like a two-speed market: to the stellar performances of the Magnificent 7 – or should we say Magnificent 5 – we could oppose the more mixed results of the rest of US markets. In the longer term, the picture is more varied: the weakness of the US fixed income market, and the fact that US Treasuries are reacting less effectively as a “risk-off” asset, points to a more structural reality: the level of US indebtedness, hitherto unaffected by the appetite of debt buyers, is approaching a threshold that prompts more circumspection about government bonds, especially at a time inflation fears could make a comeback. We are detailing these ideas in this newsletter.
Wild West Ride
There are some parallels between the markets we’ve just lived through and the Wild West Ride. February’s equity markets extended the advances that started in November 2023, even though macro signals are deteriorating, with plateauing inflation, long rates on the rise again, and drastic adjustments to rate cuts expectations (from six to three cuts) in a matter of weeks. In this environment, maintaining a neutral but differentiated portfolio approach seems wise. Asia remains promising, with the rerating of Japan not complete and with China finally showing some signs of stabilization. In the United States, if some similarities can be drawn with the IT bubble, the strong results and outsized profitability of US tech champions also underline significant differences with today. With more stretched valuation and sentiment indicators, a short-term market pause would be healthy. Finally, as rate cut expectations have adjusted, fixed income looks a more attractive asset class compared with a few months ago. We are detailing these ideas in this newsletter.
Once again?
This adage comes to mind in January, as this first month of 2024 saw the pursuit of some of the trends seen last year, either with rising long term rates, or the continued slide of the Chinese economy, not to mention reinforcing concentration of the US market around the “Magnificent Seven”. While the start of the year might suggests that, in many respects, 2024 is shaping up to be a repeat of 2023, the underlying situation looks very different: Central bankers have pivoted, and even if investors’ rate cuts expectations were overly ambitious late last year, the direction is clear. The still-dominant “Magnificent Seven” group seems less impressive individually. Finally, with the events in the Red Sea and the first elections of the year, January marks the return to centre stage of political and geopolitical risks that we will have to factor more in our investment thinking in 2024. We are detailing these ideas in this newsletter.
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