Blog: You, us, everyone

As expected, yesterday, the FED started a new interest cycle, the first cut since the COVID-19 pandemic over four years ago.

With the engineered 50bp cut, the FED recalibrates its monetary policy towards more neutral, thereby sending a conflicting signal to the market about the economy’s path forward. In fact, the FED estimates that the job market is no longer as solid as expected and that a soft landing translates into a recession, which is widely reflected in the bond market – in anticipation of a recession, the widely observed two-and-10-year Treasury yield curve, which has been “inverted” since July 2022, has rapidly “un-inverted”.

While the S&P 500 Index has recovered from a mid-summer consolidation, i.e. it rallied roughly 8.5%, now trading close to the all-time high, the global economic growth appears fragile with uncertainty among small businesses being high as U.S. consumers are exhausting their savings.

As of now, market-based consensus suggests there will be as many as 250 basis points of cuts by next December. If this scenario were to materialize, it would suggest that the Fed is “behind the curve” in easing monetary policy.

Economic Outlook – economic growth looks fragile.

The market has two contradictory views: The equity market suggests that the economy is on track for a soft landing whereas the bond market suggests that the Fed kept rates too high for too long. For now, our predominant view is that a soft landing will take place, but would expect an increased level of volatility.

For the average S&P500 company, roughly one-third of profits come from overseas. Yet, for the coming quarters, this relationship may be at risk as the expected economic recovery outside the US is not taking shape. On the contrary, general market indicators suggest the opposite. The recent decline in oil prices as assimilated with drops observed during recessionary periods. More, China is fueling investor concerns as consumer confidence is down and consumption across South-East Asia remains weak. This comes on the back of a still lingering residential property market - consolidation which might last another 2 to 3 years. This in turn has resulted, against the government's view, GDP to drop below the critical threshold of 5%.

In the US, the small business surveys suggest the level of uncertainty among small businesses, which account for about two-thirds of U.S. jobs, is around its highest since 2020. Sales expectations are at a four-year low, while hiring and capital investment intentions are also fading. Even as total non-farm payrolls remain positive, there have been net losses in small-business jobs in recent months. All this worries the bond market for than the stock market.

Investment recommendation

Looking ahead, there is probably no rate cuts in November due to the timing and scale of this first cut and the potential interference with the US election; however, it can be expected that an additional 25 basis point reduction in December, but pending the economic slowdown, the occurrence of the 2nd cut may be a little too late to maintain a soft landing.

Given this, there is no time for complacency. Investors should seek out value and neutralize any assets in which their portfolios are over-invested. Consider reducing ultra-short and money-market positions and locking in still-high rates on longer-dated debt. Look to the equal-weighted S&P 500 as a better risk-adjusted exposure than the cap-weighted version.

We continue to find compelling opportunities in financials (ex-REITs exposures), industrials, energy, materials, and healthcare, along with parts of the technology sector (mainly software – Ex-AI). The critical exposure to deal with are the capital-intensive sectors such as REITs and utilities. Pending the way forward of the economy, the expected performance is binary, i.e. +/-10 % on either side. Finally, currency diversification outside the US segment should provide some benefits to portfolios.