Weekly Wisdom – April 24, 2024

By Hightower Great Lakes on April 25, 2024

Higher Markets Absorbing Higher Rate Expectations

Fixed income yields have been under pressure as a higher-for-longer interest rate narrative has broadened across the market. 10-year Treasury yields moved from 3.8% in late December to over 4.6% today. 2-year Treasury yields jumped 20 bps following March CPI data and are back near 5%. The 2s/10s yield curve is still inverted over 30 bps and has been inverted since July 5, 2022.

Higher-for-longer interest rates place greater emphasis on fundamentals and valuations, and there are plenty of opportunities for quality on sale. Higher-for-longer interest rates will likely negatively impact duration-heavy equities, like growth and technology stocks with negative earnings.

This has been shown through sector rotation over the last few weeks, as areas such as industrials, materials and utilities are outperforming technology year-to-date. Over the last month, technology is down nearly 6%, the worst performing sector in the S&P 500.[1]

Diversification is always important in a portfolio within equities, fixed income and alternatives – and within a total asset allocation in general. 

The S&P 500 is off 5% from the highs, but to keep things in perspective, it is up 30% overall in the past 16 months. Recall, the total return average over the long term for the S&P 500 is 7.7%.

We have had a great run and given the unknowns of the Fed and interest rates, it would not be surprising to see a pause and or higher volatility. This is a time to look for “quality companies on sale,” when you can find many bargains across multiple sectors and asset allocations. 

We remain optimistic about the economy, as 70% of it is driven by the consumer – which has been supported by the strong labor market and higher wages. Inflation is still stubbornly high, but progress has been made and real incomes are up. 

Importantly, we think economic strength will continue to uphold in an above average trend and that company earnings will surpass expectations. We believe 8-10% earnings growth is achievable in the S&P 500 this year, with an emphasis not only on revenue growth but margin resilience as well.   

Chart 1: The Technology Sector Turns Flat on the Year Following March CPI[2]

Fixed Income Spreads Remain Tight, Issuance Elevated

At the end of March, year-to-date corporate bond issuance was $627 billion, up 81% y/y.[3] Investment grade yields have fallen from over 6.5% in mid-October to around 5.50% as issuances are well above average to start the year.

Earnings expectations show that investment-grade companies are well equipped for growth and have been looking to debt markets to raise capital. The soft-landing expectations and stronger economic outlook have also given companies greater confidence to borrow money.

Corporate and high-yield bond spreads continue to sit near historically tight levels. The expectation for rate cuts, which will ultimately lead to lower yields, has maintained investor demand for 5.5-6.0% yields on investment grade debt.

Corporate bond spreads to Treasuries have trended lower since topping out at +167 bps in September 2022 and currently sit at +94 bps. On the other hand, high yield spreads to Treasuries remain historically tight at +337 bps.

Chart 2: Corporate Bond Spreads Remain Near 20-Year Lows[4]

Fed Members Stick to “Higher-for-Longer” and Markets Listen

We heard from several Fed members last week, all bringing a similar tone: interest rates should remain higher for longer. Outlooks have quickly swung following continued growth and a strong U.S. consumer.

CPI data was hotter-than-expected in every print for the last four months, GDP expectations were revised higher and retail sales continue to show strong spending. In December, the expectation was for 150 bps worth of cuts in 2024. Just four months later, many strategists and investors are now saying there is a chance for no cuts this year, and that probability is looking increasingly likely.

Fed Chair Powell provided his thoughts on current economic conditions last week, which was presumably his last public appearance before the May FOMC meeting.

Powell noted that recent data has not provided the committee with greater confidence in its inflation fight, and limited confidence means keeping rates elevated. Despite the Fed’s attempts at restrictive policy, fiscal spending and pandemic-era stimulus continues to support economic easing.

Officials plan to leave rates at the current level, “as long as needed” if inflation does not trend lower to their 2% goal.[5] Powell still hopes that it will be appropriate to dial back the policy rate at some point later this year.

Minneapolis Fed President Neel Kashkari is one of the first members to hint at no rate cuts in 2024. Although not voting on rate decisions this year, he stated last week that it could potentially be appropriate to hold the policy rate steady this year.[6] He believes the committee must remain patient for as long as it takes to be fully confident that inflation is heading back toward 2%.

Rate Cut Predictions are Noisy and Volatile, We Stay Data-Dependent

The probability that the Fed will maintain its policy rate at the June meeting is currently above 80%, with a 16% chance of a 25 bp cut. This is up from a 25% chance for a hold just one month ago, when the probability for a 25 bp cut was 78%.[7]

The current expectation is for two 25 bp cuts this year, likely starting in September. Whether it is no cuts, three cuts or a hike, it remains true that rates will likely stay elevated, businesses can handle higher rates and the economy is in good shape.

Earnings growth is expected to remain strong, consumers are in a good spot and economic growth is still above trend. With inflation sticky near 3%, the Fed would need to see material economic weakness to cut the policy rate with inflation still above its 2% goal.

Chart 3: Hot Data Prints and Hawkish Fed Speak Have Pushed Fed Funds Futures Higher This Year[8]

We continue to stay data-dependent, just like the Fed. Due to the speed of change in expectations, it is plausible that markets rally on any cooler-than-expected inflation prints ahead.

Click here to read last week’s Market Note (4/18).

Disclosures

Investment Solutions is a group comprised of investment professionals registered with Hightower Advisors, LLC, an SEC registered investment adviser. Some investment professionals may also be registered with Hightower Securities, LLC, member FINRA and SIPC. Advisory services are offered through Hightower Advisors, LLC. Securities are offered through Hightower Securities, LLC.

This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is neither indicative nor a guarantee of future results. The investment opportunities referenced herein may not be suitable for all investors.

All data or other information referenced herein is from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other data or information contained in this presentation is provided as general market commentary and does not constitute investment advice. Investment Solutions and Hightower Advisors, LLC or any of its affiliates make no representations or warranties express or implied as to the accuracy or completeness of the information or for statements or errors or omissions, or results obtained from the use of this information. Investment Solutions and Hightower Advisors, LLC assume no liability for any action made or taken in reliance on or relating in any way to this information. The information is provided as of the date referenced in the document. Such data and other information are subject to change without notice.

This document was created for informational purposes only; the opinions expressed herein are solely those of the author(s) and do not represent those of Hightower Advisors, LLC, or any of its affiliates.

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[1] Source: FactSet. As of April 22, 2024.

[2] Source: FactSet (Chart). As of April 22, 2024.

[3] Source: SIFMA. As of April 2, 2024.

[4] Source: St. Louis Fed. As of April 22, 2024.

[5] Source: WSJ. As of April 16, 2024.

[6] Source: Yahoo Finance. As of April 18, 2024.

[7] Source: CME. As of April 22, 2024.

[8] Source: Reuters. As of April 16, 2024.