Wall St.: Investors don’t expect peace in US stocks until bond falls ease

Beginning with the third quarter, both assets have seen painful sell-offs – the S&P 500 is down nearly 25% year-over-year and the ICE BoFA Treasury Index is down nearly 13%. According to BoFA Global Research, the twin decline is the worst since 1938.

Yet many investors say bonds have led the dance, with rising yields falling stock valuations as market participants restructured their portfolios to meet more monetary tightening than expected from the Fed.

The S&P 500’s forward price-to-earnings ratio fell 20 in April to its current level of 16.1, a move that coincided with a 140 basis point increase in the yield on the benchmark US 10-year Treasury, which contrasts with prices. .

“Interest rates are at the core of every asset in the universe, and we won’t have a positive revaluation in equities until the uncertainty of where the terminal rate will settle is clear,” said Charlie McElligott, managing director of cross-asset strategy. in Nomura.

Volatility in US bonds has begun in 2022, with the ICE BofAML US Bond Market Options Volatility Estimate Index hitting its highest level since March 2020, with this week’s Treasury yield decline. In contrast, the Cboe Volatility Index – the so-called Wall Street “fear gauge” – has failed to reach its peak since the beginning of this year.

“We have emphasized … that interest rate volatility has been (and continues to be) the main driver of cross-asset volatility. Nevertheless, we continue to view rate volatility with unreliability,” wrote analysts at Sok Jane. .

Many investors believe that as long as the Fed is winning its fight against inflation, wild moves will continue, allowing policymakers to finally end the monetary tightrope. For now, there’s more flurry on the menu.

According to the CME’s FedWatch tool, investors were pricing in a 57% chance on Friday afternoon that the US central bank will hike rates by 75 basis points at its November 2 meeting, up from a 0% chance a month earlier. The market hit a peak of 4.5 per cent in July 2023, up from 4% a month earlier.

Next week’s US employment data will give investors a snapshot of whether the Fed’s rate hike is causing a dent in growth. Investors are also looking forward to the earnings season beginning in October, as they anticipate how a firmer dollar and supply chain snarls will affect companies’ profits.

For now, investor sentiment is largely negative, with liquidity levels among fund managers approaching historic highs, as many prefer to sit out of bullish market volatility. Retail investors sold equities for a net $2.9 billion in the past week, the second biggest outflow since March 2020, data from JPMorgan showed on Wednesday.

Still, some investors believe that stocks and bonds may soon see a turnaround.

A deep decline in both asset classes makes either an attractive investment given the potential for long-term returns, said Adam Heitz, global head of portfolio construction and strategy at Janus Henderson Investors.

“We’ve lived in a world where nothing was working. Much of that suffering is over, we think,” he said.

Meanwhile, analysts at JPMorgan said the higher cash allocation could provide a backstop for both equities and bonds, which could limit future declines.

At the same time, according to the Stock Trader’s Almanac, the fourth quarter is historically the best period for returns for major U.S. stock indexes, with the S&P 500 averaging 4.2% gains since 1949.

Of course, dip buying has been underperforming this year. The S&P 500 has had four rallies of 6% or more this year, each rebound sputtering followed by fresh bear market declines.

Wei Lee, chief investment strategist at BlackRock Investment Institute, believes that more jumbo rate hikes from the Fed could dent growth, while a slower pace of hardening could hurt bonds by further tightening inflation.

He under-weighted developed market equities and fixed income, believing that the more “tough choice” faced by central banks would lead to more market declines.

Keith Lerner, co-chief investment officer and chief market strategist at Truist Advisory Services, said equities could fall further than bonds, given the high likelihood of a recession in 2023.

“We think there will be an upward cap for equities as there will be more earnings pain and more central bank tightening,” he said.

This story has been published without modification in text from a wire agency feed. Only the title has been changed.