The ETF Portfolio Strategist: 12 NOV 2023
Trend Watch: Global Markets & Portfolio Strategy Benchmarks
Global markets posted a mixed week of trading through Friday’s close, but the net result was still enough to lift three of the four asset allocation funds that serve as strategy proxies on these pages. The moderate allocation ETF (AOM) was the downside outlier while its counterparts rose, led by the aggressive mix (AOA) with a 0.3% increase for the week. See this summary for details on the data in the tables below.
The upside bias extends the previous week’s surge, but the lack of follow-through for most of the underlying market segments still leaves your editor cautious/neutral on the near-term outlook.
Consider the current trend profile for the aggressive allocation strategy. Despite AOA’s recent pop, it’s not yet clear that the ETF’s downside bias has ended.
The optimistic counterpoint is the recovery in US stocks (VTI), which led last week’s winners for the primary slices of global markets.
VTI certainly appears to be reversing the downswing that started in July. But until the fund builds on its recent strength it’s premature to assume that the downside bias has ended.
My guesstimate is that US stocks will trade in range (relative to the 2022 high and low) until there’s more confidence about the outlook for several risk factors currently weighing on sentiment.
The path ahead for the Israel-Hamas war is top of mind, namely: Will the US be drawn deeper into a regional conflict? For the moment there’s a case for cautious optimism, but the potential still looks uncomfortably high for a quagmire that gradually escalates.
“It remains to be seen whether the conflict will escalate into a broader regional war,” observes Nouriel Roubini, professor emeritus of economics at New York University’s Stern School of Business and CEO of Roubini Macro Associates. “If it does, the global economic fallout could include a 1970s-style oil shock, crashing stock markets, and deep stagflationary recessions.”
Meanwhile, sentiment is shifting to expectations that the Federal Reserve’s interest rate hikes have ended. But Fed Chairman Powell pushed back on this idea, if only modestly, in a speech last week. Noting that the US economy may be more resistant to higher interest rates than previously assumed, he hinted at the possibility that another round or two of tightening is still possible:
“We know that ongoing progress toward our 2% goal is not assured: Inflation has given us a few head fakes,” Powell said at an IMF conference. “If it becomes appropriate to tighten policy further, we will not hesitate to do so.”
Markets continue to downplay the possibility. Fed funds futures, for instance, are currently pricing in a 90% probability that the central bank will continue to leave rates unchanged at the next FOMC meeting on Dec. 13.
In another sign of markets-based optimism, several key Treasury yields have pulled back from recent highs. The 10-year rate, for example, ended the trading week at 4.61%, well below the 5%-plus level that was briefly reached on an intraday basis in mid-October.
Rates may have peaked for this cycle, but it’s still prudent to wait for a stronger signal from bond prices. For the moment, it’s not obvious that a turning point has arrived, based on the iShares 7-10 Year Treasury Bond ETF (IEF). Despite the fund’s rebound of late, it’s still nowhere close to breaking free of its downtrend.
It’s useful to keep in mind that conditions that strengthen the case for ending rate hikes (or cutting) include weaker economic conditions, which would probably take a toll on stocks while boosting bond prices. The US economic expansion will likely persist for the near term, but growth is slowing after the blow-out GDP gain in Q3, and so 2024 is looking more vulnerable.
Genuine turning points in market are only clear with the benefit of hindsight. In real time, by contrast, probabilistic assessments are the only game in town, and on that point the odds don’t yet look sufficiently compelling in favor an extended rally in risk assets.
Then again, “If we are at the peak [in rates], then there is good times ahead” for stocks, says Dev Kantesaria, founder of Valley Forge Capital Management.
Maybe, but the evidence is still a bit sketchy and so it’s still premature for going all in on a forecast that a new bull run has started.