Monetary Policy
In this report, we present the quarterly review of the Global Fixed Income Strategy Model Bond Portfolio. The portfolio remains positioned for slower global growth momentum over the next 6-12 months, favoring government bonds over corporate debt. The portfolio also favors government bonds in countries flirting with recession where policy rates are too high (core Europe & the UK).
US monetary policy is restrictive, as evidenced by a falling jobs-workers gap. The reason that unemployment has not risen is because labor demand still exceeds supply. That will change in the second half of 2024 when the US economy succumbs to recession. Investors should increasingly favor bonds over stocks.
The sharp sell-off in long duration bonds (ticker TLT) has reached the collapsed 130-day complexity that implies a probable and playable rebound. More strategically, long-duration bonds yielding close to 5 percent are an excellent structural investment assuming central banks choose to slay inflation and the cost is a near-term recession. We discuss how to time and how to play the potential rebound.
The market has been held hostage by surging rates. Zombie companies are “alive” and are multiplying – they are highly sensitive to surging borrowing costs. Underweight Utilities to reduce portfolio duration. Maintain neutral positioning of Basic Materials but take a granular approach to allocations within the sector.
Downside risks to equities are building. Rates, the dollar, and energy prices will remain elevated into yearend. This trifecta makes a soft landing less likely than before and hurts corporate profits and multiples. However, high cash balances may offer downside protection against a sharp correction.
The bear market in US bonds will likely end with a bang rather than a whimper. Even during the secular US bond bull market of 1982-2021, cyclical bond bear markets ended only after an eruption of financial turmoil. It would be strange if this current ascent in bond yields ended without significant casualties in the global financial system.
Bulls and bears have capitulated, and the majority of the clients surveyed expect a rangebound market in the near term. Our fair value PE NTM indicates that the S&P 500 is only modestly overvalued. The continued outperformance of the Magnificent Seven faces multiple hurdles. Meanwhile, fiscal spending is unlikely to create an impetus for another leg up in equity performance.
US fiscal, monetary, and foreign policies are unlikely to deliver any dovish surprises for investors in Q4, due to the impending government shutdown, persistent inflation, and instability among OPEC+ and China.
The global downturn will be shallower than it was in 2008 and in 2020 but will last for longer. The primary reason for a more prolonged downturn is that policymakers in the US, Europe, and China will be reluctant to proactively and aggressively stimulate. The combination of rising oil prices, an appreciating US dollar, and mounting US bond yields constitutes a triple whammy for US share prices.
While we are sympathetic to the view that the Fed could temporarily achieve a soft landing, we are skeptical that it could stick that landing for very long. Stocks could strengthen into year-end, with small caps potentially leading the charge. But the rally will fizzle out next year as the global economy begins to sink into recession.