The ETF Portfolio Strategist: 1 OCT 2023
Trend Watch: Global Markets & Portfolio Strategy Benchmarks
Risk-off conditions strengthened last week. All flavors of BlackRock’s asset allocation ETFs lost ground and continue to post modestly negative trend profiles via the Signal scores in the table below. See this summary for details on the Signal data.
It’s still premature to characterize the recent weakness in markets as a clear break with the upside run that started a year ago, but the downside gap last week in the iShares Aggressive Asset Allocation ETF (AOA) suggests that the crowd remains defensive. The main question is whether markets are oversold or in the early stages of signaling a tipping point that will usher in an extended downturn. For what it’s worth, I’m still expecting neither and instead a trading range will prevail.
Meantime, the case is weak for expecting a revival of the bull run that until recently prevailed since late-2022. A new headwind that markets are still digesting: the spike in real interest rates.
Using inflation-indexed US Treasuries as proxies, real yields continue to rise and are at levels last seen in 2008. It’s debatable how much of a threat this change poses for risk assets and economies, but as Paul Krugman advises: “If this reversal persists, the sustainability of high debt will become a major issue for the first time in many years.”
Curiously, the sharp rise in real rates doesn’t appear related to inflation expectations, based on breakeven rates. The spread for the nominal 5-year Treasury less its inflation-indexed counterpart, for instance, has been relatively steady since March at roughly 2.0%-2.5%.
Other factors may be in play for driving real rates up, ranging from a view that economic resilience will last longer and run stronger than recently expected to the bond market’s inefficiency that’s pricing real rates higher than they should be.
What is clear is that the longer real yields stay high and/or move higher, the bigger the threat to risk assets, at least in the near term as markets adjust to regime shift. As The Wall Street Journal reports today: “Investors are struggling to make peace with a new reality: Interest rates are likely to remain higher for longer.”
No wonder that the major components of global markets are flashing weak trend signals. The main exceptions: commodities (GCC) and stocks in Latin America (ILF), which are currently posting neutral Signal scores. The rest of the field is trending negatively in varying degrees.
Markets, in sum, look inclined to play defense and adopt a wait-and-see outlook for the near term. Until there’s a compelling reason to act otherwise, adopting the contrarian view that it’s time to embrace risk-on is a tough sell.