It’s been a “summer of love” for both stocks and corporate bonds, but as autumn approaches, stocks are set to weaken while bonds strengthen as central bank tightening and recession fears dominate and again, notes Bloomberg.
After a brutal first half, both markets were poised for a rebound. The spark was ignited by resilient earnings and hopes that a small drop in rampant inflation would prompt the Federal Reserve to slow the pace of its rate hikes in time to stave off an economic contraction.
A nearly 12 percent gain in July and August put U.S. stocks on track for one of the best summers on record. And corporate bonds have gained 4.6% in the US and 3.4% globally since their mid-June lows. Having moved in tandem, the two items will now diverge, with bonds looking better placed to extend the rally as the flight to safety in an economic downturn offsets rising risk premiums.
The economic outlook is once again murky as Fed officials have said they are unwilling to stop tightening until they are sure inflation will not rekindle, even at the cost of some economic “pain,” according to Wei Li. global chief investment strategist at BlackRock Inc.
For government bonds, that means a potential flight to safety that will also benefit investment-grade corporate debt. But for stocks, it’s a risk to earnings that many investors may not be willing to take.
“What we are seeing at this juncture is a bear market rally and we don’t want to chase it,” Li said, referring to stocks. “I don’t think we’re out of the woods with a month of cooling inflation. Bets on a soft Fed turn are premature and earnings don’t reflect the real risk of a US recession next year.”
The second-quarter earnings season did much to restore faith in the health of American and European businesses, as companies largely demonstrated that demand was strong enough to pass on higher costs. And broader economic indicators – such as the US labor market – remained strong.
But economists predict a slowdown in business activity from now on, while strategists say companies will struggle to keep raising prices to defend margins, threatening second-half earnings. In Europe, Citigroup strategist Beata Manthey sees profits falling 2% this year and 5% in 2023.
And while investors in Bank of America’s latest global survey of fund managers have become less pessimistic about global growth, the mood is still bearish. The inflows into stocks and bonds suggest that “very few fear” the Fed, according to strategist Michael Hartnett. But he reckons the central bank is “not nearly done” with tightening. Investors will be looking for clues on that front at the Fed’s annual meeting in Jackson Hole this week.
Hartnett recommends taking profits if the S&P 500 climbs above 4,328, he wrote in a recent note. This is about 2% higher than current levels.
Some technical indicators also point to US stocks continuing to fall. A measure from Bank of America that combines the S&P 500’s price-to-earnings ratio with inflation has fallen below 20 before every market bottom since the 1950s. But during the selloff this year, it only reached until the 27th.
There is a trade that could provide major support to the stock. So-called growth stocks, including tech giants Apple Inc. and Amazon.com Inc., have been considered a relative shelter. That group led the stock’s recent rally, and strategists at JPMorgan Chase & Co. they expect it to continue to rise.
Bond advantage
In the bond world, the “layers” that make up a company’s borrowing costs look set to play into investors’ hands. Corporate yields include the interest rate paid on similar government debt and a premium to offset threats such as the default of a borrower.
When the economy falters, these building blocks tend to move in opposite directions. While a recession will increase concerns about the ability of businesses to repay their debt and widen the spread over safe bonds, the flight to quality in such a scenario will soften the blow.
“Potential damage at investment grade appears limited,” said Christian Hantel, portfolio manager at Vontobel Asset Management. “In a de-risking scenario government bond yields will come down and moderate the effect of wider spreads,” said Hantel, who helps oversee 144 billion Swiss francs ($151 billion).
This benefit from falling government yields in a recession particularly affects high-rated bonds, which have longer maturities and offer narrower spreads than their junk-rated counterparts.
“There’s a lot of risk around and it looks like the list is getting longer and longer, but on the other hand, if you’re underinvested and even out of the asset class, there’s not much you can do,” Hantel said. “We are getting more inquiries about the investment grade, which signals that at some point we should have more inflows.”
Certainly, the summer rally has made entry points into corporate bonds less attractive for those brave enough to dive back in. George Bory, head of fixed income strategy at $476 billion fund manager Allspring Global Investments and a bond evangelist in recent months, has somewhat tempered his enthusiasm for credit and rate-sensitive bonds as valuations no longer look particularly cheap.
Still, he is sticking to the bullish views he first expressed earlier this summer after the bond selloff sent yields to levels that could outpace even inflation.
“The world was becoming more bond-friendly and that should continue into the second half of the year,” he said.
Source: Capital
I am Sophia william, author of World Stock Market. I have a degree in journalism from the University of Missouri and I have worked as a reporter for several news websites. I have a passion for writing and informing people about the latest news and events happening in the world. I strive to be accurate and unbiased in my reporting, and I hope to provide readers with valuable information that they can use to make informed decisions.
