A rally in U.S. stocks that has powered on despite skepticism from Wall Street faces a reality check this week, as key inflation data threaten to shut the door on expectations of a dovish shift from the Federal Reserve.
The S&P 500 has walked a tightrope this summer, rising 13 per cent from its mid-June lows on hopes that the Fed will end its market-bruising rate increases sooner than anticipated. A blowout U.S. jobs number on Friday bolstered the case for more Fed hikes but barely dented stocks – the S&P fell less than 0.2 per cent on the day and eked out its third straight week of gains.
More upside could hinge on whether investors believe the Fed is succeeding in its fight against soaring consumer prices. Signs that inflation remains strong despite a recent drop in commodity prices and tighter monetary policy could further weigh on expectations that the central bank will be able to stop hiking rates early next year, drying up risk appetite and sending stocks lower once again.
“We’re at the point where consumer price data has reached a Super Bowl level of importance,” said Michael Antonelli, managing director and market strategist at Baird. “It gives us some indication of what we and the Fed are facing.”
Rebounds in the midst of 2022′s bear market have been short-lived and three previous bounces in the S&P 500 have reversed course to make fresh lows, fuelling doubts that the most recent rally will last.
Investors’ dour outlook was highlighted by recent data from BofA Global Research, which showed the average recommended allocation to stocks by sell-side U.S. strategists slipped to its lowest level in more than five years in July, even as the S&P 500 rose 9.1 per cent that month for its biggest gain since November, 2020.
Institutional investors’ exposure to stocks has also remained low. Equity positioning for both discretionary and systematic investors remains in the 12th percentile of its range since January, 2010, according to Deutsche Bank published last week.
For their part, Fed officials this month opposed the narrative of a so-called dovish pivot, with one of them – San Francisco Fed President Mary Daly – saying she was “puzzled” by bond market prices that reflected investor expectations for the central bank to start cutting rates in the first half of next year.
U.S. rate futures have priced in a 69-per-cent chance of a 75 bps hike at its September meeting, up from about 41 per cent before the payrolls data. Futures traders have also factored in a fed funds rate of 3.57 per cent by the end of the year.
Positioning in options markets, meanwhile, shows little evidence of investors rushing to chase further stock market gains.
One-month average daily trading volume in U.S. listed call options, typically used for placing bullish bets, is down 3 per cent from June 16, Trade Alert data showed.
“We are surprised to not see investors start to chase upside calls in fear of underperforming the market,” said Matthew Tym, head of equity derivatives trading at Cantor Fitzgerald. “People are just watching.”
Celia Rodgers Hoopes, portfolio manager at Brandywine Global, believes much of the recent rally has been driven by short covering, especially among many of the high-flying tech names that haven’t done well this year.
“The market doesn’t want to miss out on the next rally,” she said. “Whether or not it’s sustainable is hard to tell.”
Of course, investors aren’t uniformly bearish. Corporate earnings have come out stronger than expected for the second quarter, with some 77.5 per cent of S&P 500 companies beating earning estimates, according to I/B/E/S data from Refinitiv this past Friday, fuelling some of the market’s gains.
Mr. Antonelli of Baird also said a cooler than expected inflation number this week could push more investors back into stocks.
“Is there a scenario right now where inflation comes down and the Fed isn’t going to engineer a hard landing? There could be, and nobody is positioned for that.”
Others, however, are more skeptical.
Tom Siomades, chief investment officer of AE Wealth Management, believes the market is yet to see a bottom and has urged investors to avoid chasing stocks.
“The market seems to be engaging in some wishful thinking,” he said. Investors “are ignoring the age-old adage, ‘don’t fight the Fed.’”
-- Saqib Iqbal Ahmed, Reuters
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The Rundown
A tale of two funds with similar mandates and very different results
Sometimes things are not always as they seem when it comes to investing. For example, you’d expect that two exchange-traded funds with similar mandates would generate roughly comparable results. But it doesn’t always work that way, as Gordon Pape learned when doing some research on low-volatility ETFs.
Why this money manager is invested in these two ‘highest-quality’ Canadian tech firms
The last time small cap stocks were this attractive was during the 2008 global financial crisis, says money manager David Barr, who has been snapping up some of his favourite names he considers to be on sale as part of the broader market sell-off. The chief executive and portfolio manager at PenderFund Capital Management Ltd. in Vancouver, which oversees about $2.2-billion in assets, tells Brenda Bouw about his latest portfolio moves.
Confused by mixed signals in today’s economy? You’re in good company
Call it the economy that doesn’t make sense. Rarely, if ever, have the standard indicators offered such a baffling muddle of contradictory readings. Some point to still decent growth. Others say a slowdown is looming. What should investors make of all this? Ian McGugan shares his thoughts.
Strategies fund managers use to make more money from bonds - and how you can too
Volatility in bond markets has not been this high since the mid-1990s. This dramatic increase in market volatility may have younger bond managers perplexed, since many started their careers in a very different environment. Retail investors are undoubtedly stressed out, too, over what to do with fixed income in their own portfolios after encountering steep losses so far this year. As veteran fund manager and guest columnist Tom Czitron tells us, a look back on how bond fund managers used to ply their trade can provide some valuable insight on how to make more money from fixed income in today’s market.
Others (for subscribers)
Monday’s analyst upgrades and downgrades
What Dennis Mitchell learned from his first stock – a trendy American retailer
Bed Bath & Beyond jumps as retail investors chase highly shorted stocks
Ask Globe Investor
Question: My husband set up a portfolio, with one of the accounts having a lot of Phillips, Hager & North (PH&N) bond funds. As I am 74 and my husband died, I still have this bond account currently worth $360,000. As it is in a registered retirement income fund, I need to take out $15,000 to $20,000 every year. The other accounts are conservative, high-paying dividend stocks which bring me a very good income.
My husband always said to diversify. When stocks go down, bonds go up. Should I just stay with these bonds, waiting for them to recover, or dump some of them?
Answer: Your husband was almost right. When stocks go down, bond prices usually rise. But not this year. It’s the first time in decades we’ve experienced a down market in both types of securities. Your bond portfolio has already taken losses and is vulnerable to further declines as interest rates continue to rise.
So, what to do? For starters, it’s important to remember that PH&N (which is owned by Royal Bank) has one of the most respected fixed-income teams in Canada. If you decide to retain your bond funds, you can be assured they are in good hands. That doesn’t mean they’re immune from short-term losses, however. But PH&N bond funds will probably fare better than most others.
However, the company’s Dividend Income Fund is doing better in these tough markets. As of June 30, the PH&N Total Return Bond Fund was showing a one-year loss of 11.5 per cent and was down 12.3 per cent in 2022 (A/D series). The Dividend Income Fund had a one-year gain of 4.1 per cent, although it was down 10.9 per cent in the first six months of the year.
Over 10 years, the Dividend Fund is a clear winner, with an average annual return of 8.8 per cent versus 1.8 per cent for the Total Return Bond Fund.
Other alternatives to the bond funds include the PH&N Canadian Money Market Fund. The return is very low (much less than inflation), but your principal would be intact. You might also consider a guaranteed investment certificate. Their returns have moved higher, although they still fall short of inflation.
Your husband always advocated diversification, and that was sound advice. You may wish to respect his views and leave everything intact. But before you decide, I recommend a consultation with your PH&N adviser, who is in the best position to know what’s appropriate in your specific case.
--Gordon Pape
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Compiled by Globe Investor Staff