Weekly Market Update
Foreword
Access these views via the Dynamic Multi-Asset Fund, a dynamic fund designed to deliver across market environments and help investors navigate the toughest market situations.
From the desk of Our Asset Allocation team, Friday 19th April 2024.
Fearful Symmetry
Following the past weeks’ strong employment and inflation releases, Monday’s U.S. retail sales data added fuel to the narrative of persistent U.S. resilience. Fed officials, who until recently were maintaining an asymmetric policy stance of upcoming cuts (i.e. leaning towards a cut), were forced to acknowledge that perhaps inflation risks are more symmetric or balanced than previously believed, and that it is by no means assured that inflation will decline as quickly as previously hoped. The Federal Reserve Bank of New York’s John Williams made headlinesFootnote1 by pointing out that rates could even be raised if required, and Fed Chair Jerome Powell was also forced to acknowledge the lack of progress on inflation towards the target.
As a result, the previously inevitable cuts are getting pushed into the future: less than two cuts are now priced into the market for 2024, and only three or four additional cuts in 2025. With real yields also returning to a range last seen in October 2023 and nominal yields again feeling pressure from Treasury supply, the market reactions seem like a mirror image of that time.
That said, circumstances are very different than during last year’s inflation surge. For one thing, the market’s (and our) perception of recession risk has declined substantially, so that a stagflation outcome (stubbornly high inflation, high unemployment and slow growth) in a country's economy is less likely. Indeed, a healthy growth environment, even with a slower decline in inflation, might still be viewed as a successful soft landing, albeit requiring longer steady pressure on the controls.
Second, the U.S. is now the exception compared to most other developed markets, unlike the globally synchronized inflation wave faced last year, which also suggests that some disinflation can be imported into the U.S. from abroad. And finally, there are plenty of reasons to doubt the persistence of some drivers of U.S. CPI strength, notably the motor vehicle insurance premia (which are lagged effects from last year’s purchases), and rent components (which are on a declining path, although we have had extensive discussion of the U.S Bureau of Labor Statistics’ new tenant index), This is especially the case now that tighter financial conditions are no longer counteracting tight monetary policy.
So what is there to be afraid of? Maybe the answer is in the symmetric-seeming exchange of missiles and drones between Israel and Iran, which raises the risk of a geopolitical (and possibly inflationary) shock, if either party loses control of the proportional retaliations. Or perhaps in the upcoming corporate earnings season, in which various companies (including TSMC, Netflix and ASML) have already been punished by the market for imperfect narratives despite having solid earnings. Broad indices are sharply lower, despite 80% of the companies reporting so far beating expectations by nearly 10% (versus 3% consensus)Footnote2. Perhaps the weight of next week’s Treasury refunding announcement amidst substantial auction supply (which has been a source of bond market volatility in previous quarters) will be of concern.
While these are legitimate concerns, they are the types of left-tail (extremely negative) risks that the market had been safely ignoring for a few months in favor of rosier outcomes. In a market that was priced for a smooth right tail, even symmetry can be frightening.
In DMAF, the put spread collars we added during lower-volatility environments are helping to partially protect the portfolio from the renascent left-tail fears, but we maintain our overall mid-range long equity exposure. We are also reviewing the liquidity, idiosyncratic risks, and factor exposures across our single-name positions.
The Asset Allocation Team
PS: The book “Fearful Symmetry” by Anthony Zee is an enjoyable, if slightly dated, layman’s walk through (mostly particle) physics, which is often more comprehensible than the functioning of financial markets.
How can DMAF benefit investors in today’s uncertain markets?
- Provide optionality
- Enhance returns
- Control risk
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