The ETF Portfolio Strategist: 16 Oct 2022
Trend Watch: Global Markets & Portfolio Strategy Benchmarks
The search for signs that the risk-off run is ending continue in vain as risk-off signals persist across our 16-fund global opportunity set. The primary Signal indicator remains deep in bearish terrain across all markets, with one exception: stocks in Latin America (ILF), which has been posting relatively bullish readings since late-August.
ILF has been roughly flat over the two months, which translates to a strong relative performance in the current environment. Nonetheless, the headwinds that are taking a toll on markets overall are still too overpowering to suggest that this slice of global equity markets can break out of its recent trading range and run higher.
Turning to the US, small-cap shares posted the best performance (i.e., the smallest loss) last week for the G.B16 opportunity set. Is this an early clue that the small-cap premium is set to emerge anew? It’s too early to make that call, although small caps deserve close attention, in part because this slice of equities is showing signs of stabilizing, based on iShares Core S&P Small Cap ETF (IJR).
It doesn’t hurt that valuations for this group looks attractive relative to large caps.
“US small caps continue to be priced at a significant discount to their mid- and large-cap counterparts,” advises Andrew Okrongly, director, model portfolios, at WisdomTree.
The current forward price-to-earnings (P/E) ratio of the Russell 1000 Index (a U.S. large-cap proxy) sits at 17.0x, slightly above its 20-year historical median of 16.5x.
The picture is very different in small caps, where the forward P/E of 11.9x on the Russell 2000 Index (a U.S. small-cap proxy) represents a greater than 30% discount to its long-term median of 17.2x.
Meanwhile, bearish winds are still blow for US government bonds. The iShares 7-10 Year Treasury Bond ETF (IEF) fell for a ninth straight week. A bear-market rebound looks overdue in this corner, but on a strategic basis a cautious stance remains prudent. The September numbers on consumer inflation show that the core reading of CPI edged up to a 40-year high in year-on-year terms, which triggered a new round expectations that the Federal Reserve will have to keep tightening monetary policy well into the future to tame pricing pressure. Not surprisingly, Fed funds futures are pricing in a near certainty of another 75-basis-points rate hike at the next FOMC meeting (Nov. 2) and high odds of a repeat performance on Dec. 14. All of which suggests that the road ahead for the bond market still looks treacherous.
Given the ongoing run of high inflation, it’s odd that commodities aren’t showing more strength. That’s probably due to the dual headwinds of a strong US dollar and slowing economic growth, which may soon deteriorate into a recession for the US and elsewhere — two factors that historically take a toll on commodities prices. Yet GCC has been treading water for the past several months. I still see the asset class as more likely to slide than rally, but the market seems to be suggesting that the selling has been exhausted, which could be a set-up for extended rebound. Such a change isn’t obvious at the moment, but perhaps it’s time to start pondering what catalyst could spark a fresh run of higher prices. The approaching winter and a supply-pinched energy sources is an obvious starting point to consider
Looking at markets through a multi-asset-class portfolio lens still reflects a deeply bearish trend. Once again, all five of our strategy benchmarks are posting negative trending behavior in the extreme via Signal readings of -5. This will end, eventually. When? No clue, although an encouraging sign will arrive when one or more of the benchmarks rise from the -5 reading that currently dominates. ■