• Funds Blog
• January 10, 2025

U.S. Stocks Look Up as Interest Rates Near Peak

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In the first half of 2023, two significant market risks have emerged, largely stemming from rapid interest rate hikes by the Federal Reserve—a trend not seen since the 1980sThese hikes have resulted in decreased corporate profits and stagnating real wages, posing challenges for the economyNonetheless, recent indicators suggest a upswing in the economic landscape of the United States, with real wages beginning to increase again and corporate earnings showing signs of resilience and surpassing expectations.

Amidst shifting trends, our confidence has grown regarding the prospect of an impending recession in the US within the next six months as the threat of escalating interest rates appears to be waningInterestingly, the performance of China’s economy may even contribute positively to the inflation levels in developed markets, with potential repercussions for investment strategies globally.

As market dynamics shift, how do these evolving conditions shape our investment outlook? With recession risk diminishing, US stock market projections appear more balanced

Our assessment of the outlook for US equities has transitioned from a bearish to a neutral stance.

In light of these changes, we have observed a more favorable risk-return profile within the stock market, with expectations for the S&P 500 turning more upbeat than previously forecastedWe now anticipate a reduction in the threat of a US recession, supported by recent indicators showing growth in real wages and robust retail sales in July—the strongest since the beginning of the yearCompanies comprising the S&P 500 index seem poised to defy initial expectations for profit contractions in 2023, instead providing optimistic earnings guidance for the upcoming third quarterThis could signal a turning point, indicating that the second quarter might represent a trough in year-over-year earnings growthCurrently, we project the S&P 500’s earnings per share to remain flat for 2023, with a subsequent growth forecast of 9% in 2024. However, our base case reflects only modest upward movement in the US stock market over the next 6 to 12 months, with anticipated index values reaching approximately 4,500 points by December 2023 and 4,700 by June 2024.

Despite the improving sentiment, we have seen the S&P 500 experience its third consecutive week of declines, as investors weigh the possibility of further tightening measures by the Federal Reserve

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Recent minutes from the Fed’s meeting in July revealed hawkish and dovish sentiments among officials, suggesting an ongoing concern about inflationYet, some policymakers expressed apprehension regarding the risks of “over-tightening.” Overall, these meeting minutes have done little to alter our perspective that interest rates may have peaked or are nearing their zenith.

Robust retail sales data has led to renewed anxieties regarding an overheating economy, complicating matters for policymakersOn August 17, yields on 10-year US Treasury bonds surged to levels not witnessed since 2007, pushing the anticipated timeline for the first interest rate cuts to March of the following year and resulting in negative returns for US bonds thus far in 2023.

In this climate, our outlook on the US equity market has become less pessimistic, prompting a shift from bearish to neutral ratings

However, rising valuations, especially in specific growth sectors, indicate that the overall return prospects for equities remain less favorable compared to fixed-income assets for the next 12 months.

Fixed income continues to be our preferred asset class, with expectations that a slowing growth environment combined with decreasing inflation would benefit bond performanceCurrent bond yields present an attractive opportunity especially in high-quality (government) and investment-grade bonds, which are likely to offer favorable total returns while positioning themselves more advantageously than equities in the event of worsening economic headwinds.

When it comes to the stock market, we are focusing on those equities projected to catch up after lagging behind—particularly valuing equal-weighted indices over capital-weighted ones in the US marketMoreover, emerging market equities appear to hold greater potential for upward momentum when compared to their American counterparts.

Maintaining a constructive outlook on the Chinese stock market remains paramount, particularly as it aims to recover some of the lost ground

The efficacy and frequency of China’s economic stimulus measures is under scrutiny, as recent data on fixed asset investments, retail sales, and industrial production further underscored the lack of momentum in a robust recoveryPolicymakers’ latest interventions—including a modest cut of 10 basis points to the loan prime rate and the unexpected stability of the five-year mortgage rate—have left investors vigilant for further measures intended to bolster China’s economic growth and re-establish market confidence in sectors like real estate that face challenges.

Notably, we contend that the state of the Chinese economy may even encourage lower inflation rates in developed marketsAfter trailing the MSCI Global Index by nearly 20 percentage points in 2023, we expect the Chinese market will begin to recover some ground soon.

This process is underscored by increasing expectations for stronger policy support with each dataset released

Last week, the People’s Bank of China unexpectedly introduced looser policies, including a notable cut to the one-year medium-term lending facility by 15 basis pointsMoreover, following the introduction of regulatory support measures for the stock market, the benchmark loan prime rate was similarly adjusted downwards by 10 basis pointsWe expect further reductions in reserve requirements this year, along with additional cuts to the five-year loan rate to support credit demand, rebuild confidence, and promote economic growth.

Another factor at play is the relatively modest scale of investment restrictions announced by the US regarding China, lifting some of the foreboding influences overshadowing the marketUnresolved issues around key exemptions and the absence of industry-wide limitations also alleviate some concerns.

Moreover, recent regulatory resolutions concerning internet companies signal an intent to foster more private-sector development, particularly as clearer pathways emerge for growth in sectors such as AI

The realm of technology regulation appears to be steadily easing, which could further reduce perceived risks.

While acknowledging the significant reliance on a delayed economic rebound, we believe this is not the only factor to considerOur anticipation of forthcoming policy support, coupled with a sustained constructive perspective on the Chinese stock market, remains intact.

In the context of currency markets, one should be cautious about the sustainability of the recent rebound in the US dollarOver the past few weeks, the dollar has displayed signs of strength, with the DXY index rebounding significantly from its recent lows in mid-JulyAs of August 21, the DXY index has experienced a minor decline of 0.2% since the beginning of 2023, despite being down 4.5% on an annual basis midpoint through July.

Although strong economic data out of the United States is driving the dollar’s rally, we foresee a subsequent weakening of the dollar in the future

The strength of US economic data could prompt the Fed to tighten monetary policies further, yet long-term fundamental factors—including overvaluation, fiscal and current account deficits, credit rating concerns, and high US capital allocation—continue to serve as a burden on the dollar.

Market participants will be keenly observing comments from Fed policymakers during the upcoming Jackson Hole Global Central Bank Symposium, particularly those from Jerome Powell on August 25, as they seek clarity on whether the dollar's rebound can be sustained given the dynamics of relative growth, inflation, and interest rate outlooks since mid-July.

We maintain a reserved outlook for the dollarOur least favored currency is the dollar, while we favor the euro’s prospectsGiven the more rapid downward trajectory of inflation in the US as compared to Europe, American interest rates are more likely to approach their peaks ahead of those in the Eurozone

This suggests that the Federal Reserve may be inclined to ease monetary policy sooner than other central banksIn addition, the negative economic surprises that have recently plagued the Eurozone are already reflected in its currency valuations, while improvements in the Europe’s trade balance are expected to benefit the euro.

As for the Japanese yen, we perceive limited upward potential, prompting a shift from a positive to a neutral stance on its outlookIn the current landscape, characterized by the relative strength of the US economy and the Bank of Japan's subtle unwinding of yield curve control (YCC) policies, we see few catalysts that could offset the negative differential posed by short positions against the yen, which reflect a divergence of approximately 5%. That said, we still regard yen long positions as potentially effective hedges, especially when selectively applied.

(The opinions expressed in this article are solely those of the author and do not reflect the views of this publication