The ETF Portfolio Strategist: 19 Feb 2023
Trend Watch: Global Markets & Portfolio Strategy Benchmarks
Risk-off sentiment dominated trading for a second week through Friday’s close, a bias that weighed on all our strategy benchmarks. The pullback so far is modest and it’s not yet obvious that the strong rebound that’s prevailed for much of the year so far has run out of road. But the next several weeks may be decisive for deciding if the runup in global asset prices is a bear market or the dawn of a new bull run.
Meantime, our proprietary trend metrics have turned neutral to slightly bearish for the portfolio strategy benchmarks, based on the Signal scores (See this summary for design details on the strategy benchmarks).
Within the G.B16 opportunity set, stocks in Europe are now posting the strongest momentum signals. But it’s premature to read too much into this change until/if it shows some persistence. Indeed, last week VGK was more or less neutral. The latest shift is encouraging, but VGK is still trading in a tight range and it’s not obvious that the odds are skewed heavily to the upside from here on out.
The key challenge for markets in the weeks ahead is pricing in the change in sentiment linked to the Federal Reserve’s hawkish monetary policy. Until recently, the crowd has been effectively dismissing the Fed’s warnings that it may keep interest rates higher for longer. The optimism that this is just posturing has faded over the past week. One example: Fed funds futures are now closer in line with the central bank's view that rate cuts are off the table for 2023 after US consumer inflation data showed pricing pressure cooled less than expected in January.
Perhaps that’s why US equities (VTI) stalled again last week, holding in a tight range following a strong rally in January. The market may be digesting its year-to-date gains and setting the foundation for a renewed push higher. But there are several significant risk factors that still suggest caution.
Perhaps the leading threat is the history that stocks over the past five decades have bottomed only after the Fed has started cutting rates. The problem is that more rate hikes are still expected for the next two if not three policy meetings, according to the futures market. At the very least, rate hikes at this point are a very low probability event for the near term.
Otherwise, clarity is in short supply on a number of key fronts, including business-cycle risk. To cite two examples: the Conference Board’s Leading Economic Index for January is signaling recession while the Philly Fed’s ADS Index indicates business conditions are expanding at an average pace (through Feb. 11), relative to history, after rebounding from a slowdown in late-2022.
How is the Fed interpreting the mixed signals for the economy? Good question, but I suspect that no one, including the central bank, has a good answer yet. The mystery plays an outsized role in convincing me to stay defensive until the clouds begin to break and the path ahead, for good or ill, becomes clearer. ■