Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Equities reset with margins and structural inflation themes back
Peter Garnry
Chief Investment Strategist
Summary: The strong equity rally this year has faded fast in February as bond markets are beginning to second-guess their initial rosy outlook on inflation and policy rates. A significant shift higher in US long-term bond yields has finally spilled into equity sentiment sending S&P 500 futures 2% lower yesterday. High equity valuation themes were leading the declines while commodity related and defence stocks were among the best performing themes. Home Depot and Walmart earnings releases underpinned once again that operating margins are under pressure from higher wages setting equity markets up for more hiccups in 2023.
Equities tumble as long-term bond yields climb to almost 4%
S&P 500 futures declined 2% yesterday closing just above the important 4,000 level as a higher US 10-year yield closing at 3.95%, the highest since mid-November, put downward pressure and breathed new life into the structural inflation and margin compression themes. As we recently argued, the interest rate sensitivity has fallen for the general market compared to a year ago as equity valuations have come lower, but in the various growth segments such as our theme baskets NextGen Medicine, E-commerce, and Bubble Stocks, the interest rate sensitivity was very well alive yesterday down between 3.5% and 5.5%.
The best performing equity theme basket was defence, which we highlighted on Monday on the back of a nervous Munich Security Conference and the upcoming 1-year mark of Russia’s invasion of Ukraine. In the coming weeks geopolitical risks will be on the rise and the key geopolitical risk to consider is whether China increases their commitment to Russia and maybe even supporting Russia with weapons in Ukraine. This is a ‘red line’ for the US and Europe and could cause severe disruptions and mark the end of globalisation. The probability of this scenario is still low, but adding defence stocks to the portfolio would add some hedging against geopolitical risks.
Home Depot and Walmart confirms wage pressures and margin compression
Yesterday’s results from Home Depot and Walmart confirmed that wage pressures are still high with Home Depot setting aside an extra $1bn to their hourly frontline staff. Home Depot’s guidance on operating margin at around 14.5% is lower than the estimated 14.8%. Home Depot is one of the biggest winning stocks of the past three decades in the US equity market and in theory a Berkshire Hathaway acquisition target. While yesterday’s earnings release is a setback for the company and the strong pandemic boom narrative is seeing cracks it will likely be too early for value investors to get into Home Depot shares as the company is still valued significantly above the general equity market and its own long-term average valuation since 2003.
The margin compression theme we have written extensively about for several quarters picked up during the Q4 but overall companies still managed their margins a bit better than feared. However, despite energy and general commodity prices have eased over the past six months, the pressures from wages will begin eating into margins. The equity market’s sensitivity has moved from interest rates to that of operating margin because companies’ margins are rolling over from historically high levels.
The worst-case scenario this year for equities is if the bond market wakes up to the realisation that inflation is becoming more structural and less temporary. That could cause long-term bond yields to push higher and increase the equity risk premium at the same time. If that happens while earnings face an operating margin headwind then the equity market could faces significant trouble. We continue to maintain that under higher structural inflation equities will do better than bonds, but it is important for investors to be overweight companies operating in the physical world and also consider being overweight Europe vs US equities.
Latest Market Insights
Quarterly Outlook
-
-
Quarterly Outlook
Equity Outlook: Will lower rates lift all boats in equities?
Peter Garnry
Chief Investment Strategist
After a period of historically high equity index concentration driven by the 'Magnificent Seven' sto... -
Quarterly Outlook
FX Outlook: USD in limbo amid political and policy jitters
Charu Chanana
Chief Investment Strategist
As we enter the final quarter of 2024, currency markets are set for heightened turbulence due to US ... -
Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
The Fed started the US rate cut cycle in Q3 and in this macro outlook we will explore how the rate c... -
Quarterly Outlook
Commodity Outlook: Gold and silver continue to shine bright
Ole Hansen
Head of Commodity Strategy
-
Quarterly Outlook
FX: Risk-on currencies to surge against havens
Charu Chanana
Chief Investment Strategist
Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperfo... -
Quarterly Outlook
Equities: Are we blowing bubbles again
Peter Garnry
Chief Investment Strategist
Explore key trends and opportunities in European equities and electrification theme as market dynami... -
Quarterly Outlook
Macro: Sandcastle economics
Peter Garnry
Chief Investment Strategist
Explore the "two-lane economy," European equities, energy commodities, and the impact of US fiscal p... -
Quarterly Outlook
Bonds: What to do until inflation stabilises
Althea Spinozzi
Head of Fixed Income Strategy
Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain ... -
Quarterly Outlook
Commodities: Energy and grains in focus as metals pause
Ole Hansen
Head of Commodity Strategy
Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities i...
Disclaimer