For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
Are fundamentals driving markets again?
The outlook for US interest rates has been the dominant driver of markets, as the chart below shows. In the third quarter, expectations reduced sharply for a rate cut at the March 2024 Fed meeting, as the higher for longer thesis took hold. As a result, markets, in this case represented by the S&P 500 Index and US Treasuries 10 year, fell over that period. In the fourth quarter, due to lower than expected inflation prints and a more dovish Federal Reserve, expectations of a rate cut grew and financial markets rallied hard.
Having driven markets in Q3 and Q4, rates have been less relevant YTD
Source: Bloomberg Finance, L.P, 01/01/2023 – 06/02/2024 for the US Treasuries 10yr and S&P 500 Index and 23/06/2023 – 06/02/2024 for the chance of cut in US rates March 24. Past performance is not a guide to future returns.
Importantly for asset allocators, these very different periods were both dominated by equities and government bonds being highly correlated, something we have warned about since 2020. This has been the playbook for some time with markets driven by the outlook for Fed liquidity, at the expense of virtually every other factor.
However, this year, albeit not much more than a month so far, the relationship between rate expectations and financial markets has broken down. At the beginning of the year, markets were pricing in a very high chance of a Fed cut in March (their February meeting was never really in play) but a month later they have moved dramatically to pricing in very little chance of a cut, with the Fed holding a more hawkish line. Despite this, US equity markets have continued to rally this year, whilst US Treasuries have sold off, but not as much as the change in rate expectations would imply based on historic moves.
It seems the market is becoming more comfortable with higher rates and fundamentals, such as corporate earnings growth or decent economic growth, which are overshadowing the obsession with Fed liquidity.
Related to that, maybe good news is actually good news again, rather than bad news meaning good news, i.e. poor economic growth meaning a market friendly liquidity boost from the Fed. It might not just be macro fundamentals that are becoming more prominent. There is some evidence that stock specific fundamentals are becoming more important too. Certainly, within the high profile Magnificent 7, performance is more stock specific, as opposed to moving as a block due to the perceived AI halo effect, like last year. The current corporate earnings season (Q4) has no doubt played a role here. For example, Meta (which we own) has been driven higher by the announcement of its first ever dividend and strong sales, whilst Tesla and Apple (neither of which we own) were hurt by concerns around growth. The Magnificent 7, is increasingly being replaced by the Magnificent 4.
Importantly, this more fundamentalist approach is not yet evident in the wider market, with market breadth still pretty narrow and, for example, the Russell 2000 index of US small cap still underperforming.
In short though, it seems that the US economy is coping well with rates at 5%. On top of that there is scope for some rate cuts this year. The markets have moved from pricing in around six cuts this year to around four cuts, whilst the Fed is assuming three cuts still and holding a somewhat hawkish line to move markets towards their expectations.
For the macro thematic fund range, we remain fully invested but with short duration in the bond exposure, and material exposure to equity diversifying assets, such as gold, oil, agricultural commodities and the US dollar.
Anthony Rayner
Premier Miton Macro Thematic Multi Asset Team
