The ETF Portfolio Strategist: 4 Dec 2022
Trend Watch: Global Markets & Portfolio Strategy Benchmarks
Global markets continued to rebound in the trading week through Friday, Dec. 2. Is the bear market history? I remain skeptical, for reasons discussed below. But for the moment the trend is favorable and it wouldn’t surprise me to see the gains roll on. But this still looks like a bear market rally for stocks. Bonds, by comparison, are a bit more complicated.
Before I get into the reasoning, let’s review the global 16-fund market opportunity set, which again posted a mostly up-week. For details on the metrics in the table below, see this summary.
Asia ex-Japan stocks (AAXJ) led the way higher by surging 5.9% on the week. AAXJ’s bounce off its previous low is impressive, but the revival of the short-term trend has yet to spill over to the longer-term profile. If AAXJ can maintain its upside for several more weeks (or at least hold on to its recent gains) I’ll be inclined to rethink the outlook for this slice of global equities. Meantime, the near-term outlook still looks challenged.
US stocks (VTI) edged up for a second week, but here too I’m still inclined to remain defensive. Although American shares are now well off their previous lows, a convincing reversal of the downside trend year-to-date has yet to arrive. What would such a shift entail? Taking out the previous high set in August would be a good start. I give that prospect 50/50 odds at best.
The main sources of my caution fall into the category of the usual suspects, namely: slowing economic growth and ongoing hikes in interest rates. As I detail in today’s edition of The US Business Cycle Risk Report, the macro trend for the US continues to deteriorate. In fact, my proprietary business-cycle indicators are now signaling that an NBER-defined recession started in November. It’s unlikely that the stock market has fully discounted this macro risk, in part because no one’s quite sure how long a contraction will last or how deep it will get. Indeed, there are many investors and analysts who argue that a recession is still a low-risk probability.
The case for optimism includes the jobs report for November, which beat expectations with a solid gain. But payrolls are a lagging indicator and comprise just one piece of the business-cycle indexes shown in the chart above. Accordingly, the charts above tell me that the labor market will post weaker results in the months ahead.
Meantime, there’s the elephant in the room: ongoing rate hikes. Yes, the Fed is hinting that it may slow the pace of hikes, but it’s still premature to expect that the central bank will pause much less cut rates in the immediate future. That leads a related concern for risk assets: the blowback from rising interest rates is still in its early stages.
Even if the Fed stopped raising rates, the lag effects of tighter policy to date have yet to fully play out. And if you factor in the likelihood that more hikes are coming, it’s still early to assume that the worst has passed on a macro level, or that we even have a clear sense of what “worst” means for the economy.
Given the case for maintaining a risk-off posture for stocks as long as the Fed continues to tighten policy, the potential for more fallout for the economy implies that bonds will benefit as the crowd increasingly looks for safe havens. We’re seeing a bit of that in US Treasuries lately.
The iShares 7-10 Treasury Bond ETF (IEF) rallied for a fourth week. But keep in mind that the trend still looks bearish. Deciding if weaker economic conditions will overwhelm the fallout from rising interest rates is a tough call at the moment, although the market is moving slightly in favor of the former. Let’s see if that bias can be sustained through the end of the year.
Last week’s rallies continue to deliver relief to our strategy benchmarks. Once again, all five portfolio indexes posted solid gains. See this summary for design details on the benchmarks. But for the reasons noted above, I don’t expect the good times to last. There’s probably another leg down lurking for multi-asset-class portfolios, but that remains a view that’s out of sync with current market sentiment. ■