The ETF Portfolio Strategist: 8 APR 2023
Trend Watch: Global Markets & Portfolio Strategy Benchmarks
Markets rose overall for the holiday-shortened trading week, again lifting all our strategy benchmarks. The upside bias still looks a bit precarious to this investor’s eye, but for the moment caution hasn’t paid off year to date. Indeed, our portfolio trackers are up 3% to 4% so far in 2023, animated by an improving macro outlook, fueled in part by renewed expectations that interest-rate hikes have nearly run their course. See this summary for design details on the strategy benchmarks.
Upside momentum remains bullish for most of our strategy benchmarks even as recession risk, by some estimates, appears elevated. Equity markets, however, are effectively downplaying recession risk, and not without reason. For details on how the metrics in the tables above and below are calculated, see this summary.
Consider the NY Fed’s Weekly Economic Index (WEI), which rebounded in the latest update to the highest level of the year. WEI has risen for four straight weeks and reflects a re-acceleration in economic activity in recent weeks. It’s too early to know if this is a robust signal that will override recession risk. My guess: the onset of a recession will be delayed or softened, but not necessarily postponed entirely.
Much (still) depends on the incoming inflation data. Although pricing pressure continues to decelerate, the slide has been modest lately, giving the Federal Reserve cover to keep raising interest rates. Fed funds futures are currently pricing in a 70% probability for another 1/4-point hike at the next FOMC meeting on May 3.
Next week brings new US consumer inflation data for March (Wed., Apr. 12) and so markets will have another crucial data point to digest. In what may be shaping up as another hawkish sign for Fed policy, economists are projecting that core-CPI’s year-over-year rate will tick up to 5.6% from February’s 5.5%. If so, the modestly firmer inflation pace will mark the first upside change in six months and inspire the Fed to forgo a pause on rate hikes.
The US Treasury market is skeptical of this analysis, or so recent trading activity suggests. The iShares 7-10 Year Treasury Bond ETF (IEF) rallied 1.6% this week, closing at its highest level since August.
Despite the rallies in stocks and US bonds, the case for caution still resonates with your editor. The strange evolution of the business cycle is one reason. Another is my expectation that the Fed will remain hawkish for longer than generally expected.
As I’ve discussed in recent months, the central bank’s hard-won credibility, built up over decades since Paul Volcker broke inflation’s back in the early 1980s, remains threatened as long as inflation runs far above the 2% target. Until core inflation prints closer to that target, the Fed will continue to err on the side of the hawks. By that standard, the ~3.5 percentage-point spread in favor of core-CPI remains intolerable for a central bank that’s still struggling to put the inflation genie back in the bottle.
It’s not obvious that markets are pricing in this mismatch, or the incentive for the Fed to continue to break things until it obtains the outcome it’s wants and needs.
Meanwhile, there are too many dark-star risk factors lurking to assume that a revived appetite for risk will sail on effortlessly in the months ahead. Surprises in the Ukraine war, the potential for US debt-ceiling crisis this summer and inflation that stays hotter than expected, for example, aren’t easily dismissed just yet. The potential for renewed turbulence, in short, remains uncomfortably high.
I still view this year’s recovery in markets as less about substantially improved macro prospects and more of a bounce from selling that went a bit too far in late-2022. As such, I remain firmly in the neutral camp until/if incoming news and numbers offer more compelling reasons to think otherwise. ■