The ETF Portfolio Strategist: 20 Aug 2022
Trend Watch: Global Markets & Portfolio Strategy Benchmarks
And then there were none.
Last week’s upbeat momentum profile for several slices of global markets evaporated in the trading week just ended, courtesy of losses across the board for our 16-fund global opportunity set. With the return of red ink, the bullish signals for our Signal scores retreated to a mix of neutral and bearish readings. (For details on the methodology, see this summary).
The on-again-off-again bullish readings are a sign of the times as markets struggle to get a handle on the risk outlook. Take the outlook for the Federal Reserve’s interest rate hikes, which is on the short list of key risk factors for markets to digest in the near term. One narrative is that the central bank will keep tightening policy until inflation shows a clear sign of peaking and sliding. There are hints that those turning points are near and possibly are already in progress. But it’s premature to make high-confidence assessments. Meantime, the Fed is on track for another rate hike at the Sep. 21 FOMC meeting, perhaps a third-straight 75-basis-points increase, which is currently pegged as a 41% probability, according to Fed funds futures.
The optimistic spin is that through either slowing inflation, slowing economic growth, or both, the Fed will soon decide to slow, stop and then reverse its rate hikes. That view has been part of the outlook that triggered the bounce in risk assets over the last two months.
There are reasons to question this forecast, of course, but the doubts were less compelling a month or two earlier, when markets were knee-deep in suffering from the correction in the first half of the year. That was a great setup for a contrarian trade, which has since faded in a non-trivial degree.
Fast forward to the present and the bounce needs more convincing evidence that 1) inflation has genuinely peaked; 2) the Fed’s rate-hiking cycle is nearing an end if not a reversal; and 3) the economic fallout from tighter monetary policy will be relatively mild.
Any one of those items is subject to a fair amount of debate and uncertainty. Assuming all three support risk-on is a high bar. No wonder, then, that the rally in US equities (VTI) paused after four straight weekly gains. The depth of the selloff as of June may be have been excessive, but the crowd may be turning more cautious until greater clarity and consensus emerges about what comes next.
The fade on bullish momentum also applies to our portfolio strategy benchmarks (see this summary for design details). The 60/40 US stock/bond portfolio is still holding on to mild upside bias, but the rest of the field has retreated to neutral/bearish postures.
The debate about bear-market rallies, rate hikes, recession and geopolitical risk will likely keep markets betwixt and between for the rest of the month. Meanwhile, I’ll be looking for clearer signs of shifting sentiment bias, for good or ill, on the other side of the Labor Day holiday. ■