The ETF Portfolio Strategist: 04 FEB 2024
Trend Watch: Global Markets & Portfolio Strategy Benchmarks
Risks? What risks?
Despite some obvious headwinds brewing, the bulls prevailed again last week, at least for the most influential market slices. Riding this tailwind, the iShares Aggressive Asset Allocation ETF (AOA) edged up its 2021 peak and set a new record high. Momentum for global assets, based on this benchmark, remains bullish.
Confirmation for lower-risk portfolios, however, is still an event that the bulls assume is forthcoming but not yet ripe. The iShares Conservative Asset Allocation ETF (AOK) rose last week, but it’s still nowhere near its peak, in sharp relief vs. its aggressive counterpart.
Is the divergence a warning sign? Possibly. What is clear is that the higher bond weights in AOK relative to AOA is a reminder that quite a lot of the fixed-income world has yet to fully embrace the revival in animal spirits that have been driving equities markets lately, particularly in the US. See this summary for details on the metrics in the tables below.
Reviewing the primary components of global markets is reminder that the case for bullish or bearish expectations depends on where you’re looking. For stocks in Japan (EWJ) and America (VTI), the upside bias remains strong, per our proprietary Signal score of 6 on both counts — the highest possible reading for upside trending behavior. It’s another story for US Treasuries (IEF), which are still posting a tepid net-plus reading for upside momentum.
The headwind for US government securities is the ongoing news that the US economy remains resilient. Last week’s surprisingly hot payrolls data for January all but destroys any lingering doubts of economic resilience. Private-sector nonfarm payrolls surged 317,000 last month – the most in a year and more than twice as high as the consensus forecast. The robust advance extends the previous months of sharp employment gains.
Good news for the US economic outlook, but it’s another headwind for pricing in high odds that the Federal Reserve will soon start cutting interest rates. Add in last week’s comments in the Fed policy statement that reaffirmed that the central bank will continue to err on the side of caution for battling inflation and you have the persuasive reasons to cool your jets for anticipating easier monetary policy.
“The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent,” the FOMC statement said.
Fed funds futures are now estimating a 38% probability of cut at the next Fed meeting (Mar. 20), pushing up the estimating tipping point to May 1 for the start of dovish policy.
Meanwhile, Treasuries (IEF) are in a holding pattern, presumably watching and waiting for data that supports (or rejects) the revised May 1 rate cut forecast, currently at a 90% estimated probability. The bond rally that started in Q4, but is currently in hibernation, is hanging in the balance.
The widening conflict in the Middle East may also reshuffle the calculus. In the wake of airstrikes on Houthis in Yemen and Iran-backed militias in Iraq and Syria in recent days, there are new concerns that hostilities in the region are spreading anew. Depending how the new phase of conflict plays out, it’s possible (likely?) that investors will run for cover and rush into Treasuries at some point, thereby reanimating the stalled bond market rally. That would be good news for bond prices, probably at the expense of stocks.
The challenge for investors is that factoring in geopolitical risk (and behavioral responses) is mostly art vs. science. But at least we know where to start this Sunday afternoon: Will Iran respond to the US missile strikes on its allies in Iraq and Syria? If so, how will Washington react?
So far, markets have mostly shrugged at the widening war, and for now there are minimal signs that investor sentiment is set to change in a meaningful degree. The trend holds… until (if) it doesn’t.
Forecasting tipping points on such matters, however, is devilishly difficult, to put it mildly. That leaves the crowd with a familiar set of choices: shift to a defensive position in portfolio design, continue to embrace risk-on, or straddle both sides with some creative hedging.
How to choose? As always, the first question is reassessing your risk tolerance and time horizon. That’s a tricky task too. The good news: it’s a lot easier than trying to predict the decisions in Washington, Tehran and elsewhere in the Middle East — and how the crowd reacts.