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After an up and down start to the year, equity markets like the S&P 500 Index have traded in a much tighter range over the past couple of months. Why do investors seem so directionless?
Investors are playing the waiting game right now. In particular, they’re waiting for the U.S. economy to soften enough for the U.S. Federal Reserve to cut rates. Such an event – as the theory goes – would catalyze risk assets and lead to a much-desired breakout in stocks as lower rates spur demand and drive the economy (and profits) into a new expansionary cycle.
Yet that reality may not be close at hand. Yes, there are signs that economic growth is weakening, but the data is mixed at best. Take the U.S. labour market, for instance. Even though weekly jobless claims have ticked up over the past few months, the U.S. unemployment rate edged down in April and hit a 50-year low of 3.4%. Moreover, while the recent bank turmoil could result in tighter credit conditions going forward, the U.S. consumer remains remarkably resilient to date – at least based on April’s 0.8% increase in consumer spending.
That could change of course. In fact, we believe it’s very likely that the U.S. economy is headed for a recession due to the lag effects of raising rates so quickly. But the Fed probably needs more definitive evidence of a slowdown before indicating a readiness for an actual rate cut. Instead, it seems poised to raise rates one more time in June before taking a potential pause to assess the ongoing strength of the economy and decide either that more rate hikes are warranted to bring inflation back down to the central bank’s target of 2% or that looser monetary policy is finally necessary to help prevent a deep and protracted recession from occurring.
While a Fed “pause” would not be enough of a catalyst to move equity markets significantly higher from here, it’s a step in the right direction. But how the market reacts will largely depend on how long the Fed remains on hold once it makes that decision. Remember, markets are currently pricing in two rate cuts by the end of the year, so if there’s an extended pause, it’s unlikely that stocks would rally for long.
That doesn’t mean markets would necessarily fall from here if the Fed doesn’t start cutting rates by the end of the year. They could easily remain rangebound like they have over the past two months. Still, without another positive catalyst on the horizon, investors may be more susceptible to downside risks or “potholes” than would otherwise be the case.
For instance, the possibility of a U.S. debt default had the potential to severely disrupt markets, and so too does the Ukraine War – especially if Russia continues to lose battleground and ramps up its aggression in more sinister ways. And what happens if inflation proves stickier than expected? Does that mean the Fed ends up raising rates even more in the coming months?
At best, then, it seems like markets are set to tread water for a little while longer. In doing so, it’s also likely that investors continue crowding into a small number of “quality” technology stocks that are thought to provide greater downside protection in this type of environment. But that’s not necessarily a good thing.
Healthy equity markets are generally those that offer broad-based opportunities, not narrow ones, and the market’s ongoing fixation with just a handful of stocks could lead to more volatility if a new and legitimate shock to the system materializes in the days ahead.
Kevin McCreadie is Chief Executive Officer and Chief Investment Officer at AGF Management Ltd. He is a regular contributor to AGF Perspectives.
Notes and Disclaimer
© 2023 by AGF Ltd. This article first appeared in AGF Perspectives. Reprinted with permission.
Commentary and data sourced Bloomberg, Reuters and company reports unless otherwise noted. The commentaries contained herein are provided as a general source of information based on information available as of May 30, 2023, and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Market conditions may change investment decisions arising from the use or reliance on the information contained herein. Investors are expected to obtain professional investment advice.
The views expressed in this blog are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds or investment strategies.
AGF Investments is a group of wholly owned subsidiaries of AGF Management Limited, a Canadian reporting issuer. The subsidiaries included in AGF Investments are AGF Investments Inc. (AGFI), AGF Investments America Inc. (AGFA), AGF Investments LLC (AGFUS) and AGF International Advisors Company Limited (AGFIA). AGFA and AGFUS are registered advisors in the U.S. AGFI is registered as a portfolio manager across Canadian securities commissions. AGFIA is regulated by the Central Bank of Ireland and registered with the Australian Securities & Investments Commission. The subsidiaries that form AGF Investments manage a variety of mandates comprised of equity, fixed income and balanced assets.
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