The ETF Portfolio Strategist: 21 APR 2024
Trend Watch: Global Markets & Portfolio Strategy Benchmarks
Markets took another hit last week, raising the risk that the recent peak in asset prices won’t soon be revisted. The combination of a geopolitical risk, sticky inflation, and, increasingly, worries about the rise of government debt levels continues to weigh on investor sentiment. There’s also a growing sense that interest rate cuts are still nowhere on the near-term horizon.
But if the view that the glass is half empty resonates a bit more with each passing week, optimists can still take the other side of the debate and argue that markets have been surprisingly resilient in the face of an ongoing list of risk factors. From a US perspective in particular, a key source of optimism remains a robust economy. This Thursday’s initial estimate of US GDP for the first quarter (Apr. 25) is widely expected to post solid growth, albeit conspicuously below Q4’s pace. Nonetheless, the projected +2.5% conenseus forecast for Q1, if correct, will dispense any lingering concern that recession risk is stalking the US. At the same time, a softer expansion will help temper concerns that sticky inflation is a prelude to a fresh run of reflationary pressure.
At the same time, markets remain in a discounting mood, paring prices for a third straight week, based on a set of global asset allocation ETFs. Leading the red-ink brigade: the aggressive strategy (AOA), which shed 2.0% in the trading week — the deepest weekly setback since the rebound off of last year’s low started in October.
The strength of the previous rally was strong enough so that markets can continue to retrace previous ground without triggering a new bearish signal. But the margin for comfort is wearing thin. Note that all the asset allocation funds in the table above are now posting Signal scores in the neutral range. See this summary for details on the metrics in the tables below.
The key question: At what point does a correction slip over the line and trigger a risk-off posture for a strategy designed for medium- and long-term investors? That’s a gray area, of course, and much depends on the specifics of each investor’s risk tolerance, time horizon and other factors. Generically speaking, however, I’m still persauded that we’re not yet at a tipping point.
Using AOA as an example, the 5-week average for the ETF is still well above its 20- and 50-day counterparts. That doesn’t mean that the markets can’t extended losses well into the future from here, but in the realm of making calculated risk guesstimates in real time, with data in hand, I’m still on the fence, at worst, in calling a top.
Keep in mind, however, that quite a lot of market euphoria has been deflated and so investors are less inclined to dismiss negative news from here on out. That’s a healthy change if you’re looking out a few years, but it also creates a higher level of vulnerability for markets in the short term.
It’s also notable that when profiling the major components of the world’s markets, commodities now stand out as an isolated upside outlier. Meanwhile, government bonds are at the opposite extreme, signaling an extreme bearish profile.
Is the bond market telling us that the potential for rate hikes is rising? That’s one interpretation, although the pushback to that view is that Fed funds futures aren’t entertaining the possibility. Rather, it’s still all about guestimating when rate cutting will begin, and on that front the crowd is pricing in September at the earliest, although the November FOMC meeting is considered a more likely start.
The logic of the feedback loop, however, needs to be considered. A key factor for why rate cuts have been delayed is the economy’s strength, which in turn has slowed disinflation, perhaps to a standstill. As a result, the Fed can afford to be patient with rate cuts.
By contrast, if the economy’s growth rate continue to fade (vs. stabilizes at/near the current pace), that would tip the balance in favor of rate cuts, which in turn would support bond prices and perhaps trigger a rally in fixed income.
Would rate cuts in that scenario inspire investors to revive the upside run for stocks? I have my doubts, but then again I’ve been routinely surprised by markets and macro over the past several years.
Meantime, I remain focused on what’s obvious and what I assume remains relevant: trending behavior in markets. On that point, the recent downturn in AOA and its counterparts has caught my attention, but it still falls short of reaching bearish tipping points. Given the current climate, however, I’m not ruling out the possibility for a tipping point. But for now the odds still don’t lean in that direction. Let’s see if the week ahead changes the calculus. ▪