By Daniel McGarvey, Portfolio Analyst
Two months into 2023, it is clear there is still much uncertainty surrounding the outlook for inflation and the markets. Various key metrics have surprised investors in recent weeks, such as a 5.4% personal consumption expenditures (PCE) inflation print (versus 5% expected), an increase in nonfarm payrolls of 517,000 (versus 187,000 expected), and only 68% of S&P 500 companies beating fourth quarter earnings estimates.
Of course, none of these figures was a surprise to everyone, given that the dispersion of opinions on Wall Street is exceptionally wide. It seems just as easy to find a major firm projecting that the U.S. economy reaccelerates from here as it is to find one projecting a hard landing with lower lows for equities. Other recent developments that imply greater concern ahead include a surge in projected government servicing costs amidst a contentious debt ceiling debate, increasing rate hike expectations, and a strengthening relationship between China and Russia.
As challenging as the rest of the year might be, Stonebridge is actively positioning for whatever this environment may hold by increasing quality on both the equity and fixed income side. We believe we are returning to a time where fundamentals matter, and we favor segments of the market we believe can provide returns without undue risk.
On the fixed income side, the good news for less-optimistic investors is that there is finally some reward for being cautious. After over a decade of hearing the TINA mantra (there is no alternative) for equities, investment-grade bonds yields are now similar to or better than S&P earnings yields. Additionally, short-term treasury rates are significantly exceeding the dividend yields on equity sectors that traditionally attract income investors, like utilities and consumer staples (chart below as of Feb. 23, 2023). That’s not to say that treasuries will necessarily outperform stocks going forward, but we have returned to an environment where low-risk or risk-free investments are more palatable.
After a hot start to the year, the S&P 500 gave back some gains by returning -2.4% in February. Persistent inflation and tight labor conditions led the market to price in a terminal Federal Funds rate of 5.4% as rates rose across the board. The Bloomberg US Aggregate Index returned -2.6% as the 10-Year Treasury rate rose to 3.9%, and high-yield credit spreads narrowed to 4.2%.
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Daniel is a Portfolio Analyst at Stonebridge Financial Group and works on portfolio analysis and other related tasks. When away from the office, Daniel spends his time playing guitar, reading, and exploring the outdoors.