Macro
Analysis of markets has been challenging as the economic models lost a large portion of their economic power due to the amount of fiscal and monetary stimulus. In addition, till October, we had ‘bear steepening’, which is very rare with few past instances and a patchy precedence for what follows.
The consumer is slowing but not stopping, with robust demand data and an overall positive economic outlook. Nevertheless, the consensus expectation is that PCE inflation will return to the 2% target sometime next year. So far, disinflation has been powered by the decline in goods prices, but the expectation is that it will also start coming from the core services components, especially from the lagging housing costs data.
Rates
In terms of buyers in the rates market, individual investors now represent a much greater demand as they try to lock in attracting rates. Individual investors, who have not seen income from the fixed income market in 16 years, are rushing in to lock current rates. Individual buyers are much more price-sensitive, and the risk is that interest rates can go back up again. However, current rates look extremely attractive from the perspective of someone who is either planning to retire or already retired. Those who are most price sensitive and afraid of duration risk may prefer to stay away from maturities beyond seven years and invest in some well-diversified intermediate-term US Treasury bond products such as IEI (iShares 3-7 Year Treasury Bond ETF).
Having regular and predictable issuance of treasuries across all maturities (short, intermediate, long) is critical for the liquidity of the market to apply laddering across the curve. It is also important to note that to judge the size of the short-term market; we need to consider the size of the $8t FED balance sheet that pays the overnight repo rate.
Credit
High Yield market looks attractive with yields over 9%. Overall, the total yield in the credit market is quite attractive, but investors must ask if those tight credit spreads are enough compensation for what the FED sees as the slowing economy. With the potential further slowdown in demand and any shock to the cost of capital, there could be significant distress in the lower-quality portion of the high-grade market. Many investors predict that over the coming months, spreads can widen significantly. Still, at the same time, they also expect a decline in interest rates, which should offset some of the negative price impact.
The dispersion between the corporate bonds’ performance will increase as we move to the environment of higher capital costs and the economy’s deceleration starts to kick in. In this environment, there should be plenty of opportunities for active fixed-income investors who can perform fundamental analysis to carefully select attractive assets for their portfolios.
Equities
Equity volatility remained low throughout the year. VIX was below 2022 and 2021 levels and notably below the long-term average (just over 19.5). Usually, VIX stays lower for some time after periods of increased volatility.
Relatively to other equity markets, the US has a significant lead, with a large cap and, more specifically, mega-cap tech leading the pack. Since the start of November, however, the market has started catching deep breaths, with now 80% of stocks above their 200 DMA. The year-end rally is in full force, with sentiment becoming more bullish by the day.
Interestingly, the defensive stock’s relative valuation is at a deep discount compared to the rest of the market. At the same time, economic sentiment remains well below investor’s sentiment.