The ETF Portfolio Strategist: 05 NOV 2023
Trend Watch: Global Markets & Portfolio Strategy Benchmarks
When markets surge, the first question that’s top of mind: Does the rise change the prevailing trend? It’s tempting to answer “yes,” given the strength and breadth of last week’s rallies. But put your editor down as skeptical. The reasoning boils down to the trite but forever relevant observation: one data point a trend does not make.
To be clear, I still think we’re in a trading range for risk assets, but last week’s actions suggest that range could be higher than recently assumed.
On the other hand, we shouldn’t be so cavalier as to dismiss the possibility that markets are embarking on a new run higher. If there’s one constant in this business, surprise and uncertainty are the evil twins that forever torment the best-informed guesstimates from analysts. And so this is a good time to remind ourselves that what passes as the highest grade of analytics in this space is estimating probabilities. With that in mind, last week’s dramatic pop in prices moves the needle, but far less than the breathless headlines following Friday’s close imply.
Let’s start by recognizing that the case for optimism certainly took a turn for the better last week, if only on the margins. The across-the-board rallies for the asset allocation ETFs used as strategy proxies on these pages delivered solid gains, led by a sizzling 5% rise in the aggressive allocation ETF (AOA). See this summary for details on the data in the tables below.
Looking at AOA’s weekly price chart, however, suggests caution is still recommended. The 5% increase clawed back two weeks of losses and then some, pushing the fund’s weekly close slightly above its 10- and 40-week averages. Encouraging, but it’s not yet obvious that this is more than a rally within an ongoing downtrend (or a new bout of volatility within a trading range bounded by Jan. 2022’s high and Oct. 2022’s low.
The next several week’s will provide a crucial test for the newly minted bulls (and by extension folks like me who still favor a more defensive posture). A follow-through rally in the days, and perhaps weeks, ahead wouldn’t be surprising. Indeed, it’s hard to ignore a rally that’s buoyed one of the weakest slices of global markets this year — property shares. For now, at least, the last has become first as US (VNQ) and foreign real estate (VNQI) took wing by nearly 9% in the trading week through Friday.
But once again, the weekly chart profile implies that’s it’s premature to abandon a cautious stance. Despite VNQ’s red-hot advance, the bearish bias for the ETF still looks intact.
Keeping an eye on bonds is the priority for deciding if staying defensive still carries weight. After all, it’s the crowd’s attitude adjustment last week that changed the tone, in no small part due to the renewed forecast that the Federal Reserve has hiked its last interest rate for this cycle.
Where did investors get that idea? The central bank left its target rate unchanged again at its policy announcement last week. A softer-than-expected rise in payrolls for October is widely viewed as corroborating evidence that the economy is on track to slow in the fourth quarter after a blowout gain in Q3 GDP.
The iShares 7-10 Year Treasury Bond ETF (IEF) celebrated the change in ex ante perspective with a strong 2.0% rise. But there’s a long way to go before IEF starts to look bullish again.
In fact, we’ve been here before with IEF (and bonds generally), only to be disappointed. Granted, at some point the disappointment will end and the string of head-fake rallies will give way to the genuine article. Are we at that point? Maybe, but I think not.
Why? Lots of reasons. Perhaps the most compelling one: IEF’s trend remains bearish. Speculators may want to rush in and bear the risk of being early on the possibility that skeptics such as yours truly are wrong. But the bias on these pages is erring on the side of low-to-moderate risk, and on that score the case that the bond market has hit bottom smells a touch premature to me.
In short, I still prefer to be late rather than early in the current climate. The main risk that my timing call is wrong: the US economy slows more than expected in Q4 and beyond, which juices bonds via the safe-haven trade. I see that as a low-probability risk for now, as explained in today’s issue of The US Business Cycle Risk Report, but conditions are fluid and so additional signs of economic weakness could quickly change my reasoning.
You’ll probably learn if I’m right or wrong over the next several weeks. Meantime, a ~5% yield in cash and equivalents takes a lot of the sting out of being light on bonds (and stocks).