Category: Insights

While the US economy has managed to display surprising strength thus far, it is difficult to see this continue given the unbridled growth in federal debt. Bond markets are expressing their concerns with rise in yields to 16-year highs. Stock markets are likely to catch up at some point in time.

Markets continue to remain unsettled by concerns around US policy. Monetary policy has been closely followed and, to a certain extent, ‘baked into’ market prices. But the unbridled increase in debt, as well as the politicisation of fiscal policy, is making markets extremely nervous.

Markets have now accepted two narratives – “higher (interest rates) for longer” and “soft landing”, i.e., normalized inflation without a significant slowdown. In our view, these are not compatible with each other, especially given the high level of debt in the US. 

The resilience in the economy has been mainly thanks to expansionary fiscal policy and some proactive management by businesses. Both of these are running on borrowed time. 

As such, we feel a significant slowdown has only been postponed by a few quarters and that investors are not getting properly rewarded for taking on US stock market risk.

The Federal Reserve seems to have finally convinced the markets that interest rates are likely to stay ‘higher for longer’. This has led to a bear steepening in the US Dollar yield curve with the long end at the highest level now since 2007, and moved the sentiment pendulum in equity markets firmly towards ‘fear’…

US inflation data came in somewhat higher than expected, but markets have remained rangebound. Focus has shifted to the outcome of the FOMC where, even though the expectation is that rates will remain steady, forward guidance is likely to have a meaningful impact.

As expected, markets focused on economic data to decide on next steps. 

Both GDP and employment data suggest that the economy is starting to cool, which should give the Federal Reserve support to pause its hiking cycle.

Several important events took place last week. Nvidia beat already elevated expectations by a wide margin for the second time in a row. The Federal Reserve reiterated in no uncertain terms its intention to keep interest rates ‘higher for longer’. And the BRICS group added six new countries and now represents almost a third of global GDP.

Despite all this, the markets didn’t move that much. We expect markets to remain somewhat lacklustre for some time, with increased focus on upcoming growth and employment data.

Contrary to expectations at the start of the year, US stock markets have delivered strong returns in 2023.

Investor sentiment has also swung from extreme pessimism in October 2022, when markets had corrected sharply, to extreme bullishness in July 2023. 

Headline economic data supports this change in mood.

GDP data reflects an economy that has been growing on-trend for at least 4 quarters. Meanwhile, CPI has declined steadily and appears to be on track to meet the Fed’s target. And this has been achieved without an uptick in unemployment, which continues to hover around 50-year lows.

Zooming out, the facts are a bit more troubling.

U.S. debt was downgraded for the second time in history by Fitch, citing long-term governance challenges. 

Moody’s downgraded the credit ratings of several banks and put the ratings of several others on standby for reviews, due to ongoing challenges in that sector. 

Industrial data continues to show deterioration.

Corporate earnings beat expectations, but mainly because the latter were steadily guided lower.  Actual revenues were in fact lower in comparison to the previous year by a wide margin.

Valuations look expensive from a historical perspective by most metrics.

And the Federal Reserve has repeatedly announced its intent to keep interest rates ‘higher for longer’.

We remain underweight U.S. equities. 

On the other side of the globe, China has disappointed with its post-pandemic recovery and is clearly dealing with some structural challenges. 

In these rather cloudy skies, emerging markets including the GCC offer potential bright spots. Not having given in to the financial profligacy of their Developed Market peers, and buoyed by lower debt and better demographics, they look poised for a strong future.

The downgrade by Fitch of the sovereign risk rating of the United States to AA+, the second time this has happened, has put a lid on the market’s risk appetite.

We believe this could be the correcting trigger that we mentioned in our previous newsletter, and is likely to be another good opportunity to add duration in investment grade fixed income.

Mood in the markets has shifted to extreme optimism, as the dominant narrative is that the economy has managed to control inflation without going through a recession. Corporate earnings have also been better than feared. We feel it’s time to become even more selective..