Constituent policy

Stocks rally continues on political pivot optimism

What happened?

The S&P 500 rose another 3.1% on Tuesday, after weaker-than-expected U.S. jobs data buoyed hopes the Federal Reserve could adopt a less aggressive stance sooner than expected. . Bonds rallied alongside stocks, with 10-year Treasury yields falling 1 basis point to 3.63%, continuing the reversal from last week’s sharp rise. Fed funds futures predict a peak in policy rates of 4.47%, but the peak is now expected a little earlier, in April 2023.

The latest job vacancies data in the United States (JOLTS) indicates an easing of tensions in the labor market. Job vacancies fell by 1.1 million to 10.1 million in August, the largest monthly decline since the start of the COVID-19 pandemic in April 2020. This follows Monday’s ISM US manufacturing PMI. September, which fell to 50.9 from 52.8 in August, suggesting that the Fed’s aggressive policy is paying off.

The US dollar index weakened 1.4% to 110.18 on the news. In Europe, the Euro Stoxx 50 rose 4.3% and the yield on the 10-year German Bund fell 5 basis points to 1.87%.

While U.S. tech stocks led Tuesday’s rally as yields softened (Nasdaq +3.3%), energy stocks also received a 4.3% boost as Brent crude oil prices rose. gained another 3.1% ahead of Wednesday’s OPEC+ meeting, when the group is expected to announce a production cut.

Helping to support dovish sentiment, Australia’s central bank surprised markets on Tuesday by raising interest rates 25 basis points lower than expected after four consecutive 50 basis point hikes. With cash rates at a nine-year high of 2.6%, Reserve Bank of Australia Governor Philip Lowe said they had already “increased significantly in a short time”. The move led to the biggest intraday drop in 3-year government bond yields since October 2008.

In the UK, 10-year gilt yields fell another 9bps to 3.87% and the pound rose 1.3% against the US dollar as risk sentiment improved after the Chancellor Kwasi Kwarteng said the government would present its statement on how its fiscal expansion would be funded from the originally planned date of November 23.

What are we waiting for?

The weaker JOLTS data supported investors’ perception that Fed actions are cooling the labor market, one of the prerequisites for the Fed to suspend rate hikes. Data is volatile and subject to revision, but job vacancies fell from 11.9 million in March to 10.1 million in August. Attention will now turn to Friday’s labor market report. Slower growth in payrolls and wages, or a rise in the unemployment rate, could further fuel positive sentiment regarding Fed policy.

Tuesday’s price action is a continuation of Monday’s rally after the weaker but still expansionary ISM print supported hopes of a soft landing, and a lower price paid component raised hopes that inflation is moderating. The two-day rally follows the S&P 500’s longest streak of quarterly declines since 2008.

Looking ahead, we believe that the combination of historically weak sentiment, better valuations and a decline in some measures of inflation expectations should help generate periodic rebounds. The path will be bumpy; even with a drop in JOLTS to 10.1 million, there are only 6 million unemployed (i.e. 1.7 jobs per person), which could drive up wages. The Atlanta Fed Wage tracker is at 6.7%, well above the Fed’s inflation target. In addition, achieving a sizable drop in job vacancies could lead to a rise in the unemployment rate – the median FOMC forecast is 4.4% for 2023 – and an increase of this magnitude in the past has always been accompanied by much weaker economic activity.

For a more sustained rally in equities, we believe markets will need indications of a clear downward trend in US inflation (i.e. at least three months of core PCE inflation of 0.2% month-over-month or less), as well as other signs of a cooling labor market, which could then allow the Fed to pause its rate hike cycle.

In the oil market, with a significant production cut already expected, we believe anything below a 0.5mbd curb from OPEC+ could lead to renewed pressure on crude prices in the near term. .

How do we invest?

We don’t think this is an environment to position for a single scenario to materialize; we recommend investors look for opportunities in a range of scenarios:

Invest in value. The combination of higher inflation and rising interest rates tends to favor an allocation to value stocks over growth stocks, a trend we have seen this year with the value outperforming by 12 basis points. percentage since the beginning of the year. Our research also shows that in the 12 months since the Fed’s last rate hike, value stocks have outperformed growth by 4.3 percentage points. For those looking for sector positioning, a drop in OPEC+ could help Brent prices rebound to USD 110/bbl by the end of the year, supporting a further rally in energy stocks.

Add defensive exposure. Central bank tightening is one of many headwinds to economic growth, which means investors should add defensive exposure, such as consumer staples in stocks (offering a beta of 0.7), or resilient credit and sustainability bonds in fixed income. The Swiss franc and the US dollar, two safe havens exposed to conclusive rate hike cycles, are among our currencies of choice.

Look for uncorrelated hedge fund strategies. An environment of high inflation and rising rates has led stocks and bonds to move together, with both down since the start of the year. But this difficult environment for “traditional” diversification has favored hedge funds, particularly macro funds, which are able to take positions in markets, instruments and asset classes in order to cope with changes in the environment. macro environment and increased uncertainty. One such trade they have benefited from is long commodities and short rates, helping to deliver a positive return of 9.3% year-to-date through August, based on the HFRI Macro (Total) index.