The renewed hard-line stance of the Federal Reserve is prompting investors to consider how an interest rate regime could affect US equities “higher for longer”. Some believe that a long road awaits them.
Although stocks have risen in periods when rates hovered around current levels, some investors worry that the combination of high bond yields and persistent inflation bodes poorly for equity returns. if the Fed follows through on the message of higher and potentially faster rate hikes that Chairman Jerome Powell launched this week.
Jonathan Golub, managing director of Credit Suisse, is among those with a gloomy outlook for equities. It describes an environment in which persistent inflation squeezes corporate profit margins and investors scorn stocks in favor of Treasuries and other short-term debt, while yields are at their highest levels in nearly two decades. for some maturities.
“A practically guaranteed six-month (Treasury) yield at 5.25% changes the dynamics for investors when the stock market looks shaky,” said.
“We would have to get risk-adjusted returns on equities of at least 1-2 percentage points higher than that, so in that environment stocks are not worth it and are dead money.”
Golub expects the S&P 500 to end the year near 4,050, about 1.5% above its current level, and to deliver single-digit annual returns through at least 2025 as inflation falls more gradually than expected. many investors wait.
A stagnation in US equity yields would deal a severe setback for investors who posted annual gains of 16% or more in the S&P 500 in four of the six years ending in 2022, when interest rates sank to lows. historical in 2020.
Of course, there is no guarantee that such an environment will await us.
Investors will closely watch Friday’s US jobs data and next week’s consumer price report, which Powell said this week will be key factors in determining whether the central bank will have to return to rate hikes at scale that rocked the markets last year.
At the moment, markets are pricing in almost a 75% probability that the Fed will raise rates by 50 basis points at its meeting on March 22, to a range of between 5.00% and 5.25%, against 9%. from a month ago.
The expectation for the Federal Reserve rate hike has also changed: investors now see a 56% chance that the central bank will place them at 5.75% and a 32% chance that it will raise them to 6%.
Equity valuations, meanwhile, appear overstated given the likelihood that rates will remain high, hurting future returns, Nicholas Colas, co-founder of DataTrek Research, wrote in a report this week.
“The S&P 500 is trading at 17.5 times the 12-month future earnings forecast by Wall Street analysts, which still looks too high to us given the uncertainty around rate policy and economic growth,” he claimed. “Therefore, we remain cautious on US equities.”
Still, stocks have managed to hold onto their year-to-date gains, despite rising bond yields, with the S&P 500 up 4% and the Nasdaq Composite nearly 11%. Some investors believe that the markets will continue to rise.
“You can still make money with stocks, but you have to be in the right segment”, tosigned Nancy Tengler, CEO and Chief Investment Officer of Laffer Tengler Investments, in a recent note. “So cyclicals do well in this particular environment, and that’s what we focus on.”
However, Max Wasserman, a senior portfolio manager at Miramar Capital, believes the Federal Reserve has to raise rates another 100 basis points to tame inflation, creating an environment that is likely to be unfriendly for US stocks.
Wasserman focuses on dividend-paying stocks and bonds, which he believes offer more attractive returns in the short term as valuations remain high.
He doesn’t expect the equity market to see a sustained rally until the Fed starts cutting rates in the second half of 2024.
“You no longer have to cover your nose and invest in shares because there is no other alternative”said.
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