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Introduction Assessment on US Equities:
In this blog post, we will provide an overview of the current state of US equities and government bonds. We will discuss market valuations, sector performance, and the implications for investors. Please note that the content has been extracted from the video ITPM Flash EP29 to ensure it is plagiarism-free.
US Equities:
The US equity market has had a strong start to the year, leading some to claim that stock market valuations are expensive. However, it is important to remember that the market is composed of individual stocks, and not all stocks are expensive. While some indices, such as the NASDAQ, are trading at high valuations, there are still relatively cheap sectors available, such as energy, small-cap value, utilities, and staples.
Defensive sectors have outperformed cyclical or commodity-driven sectors in the first two weeks of the year. This can be attributed to the expectation of modest earnings growth and the desire for safer investments in uncertain times.
Valuation Analysis:
To determine whether the S&P 500 is expensive at its current level of 4,800, we can deconstruct its valuation. Assuming an EPS growth rate of 3-4% and a forward P/E ratio of 21 times, the S&P 500's earnings yield is approximately 4.75%. Historically, equities have delivered a real return of cash plus 4.5%. Therefore, the S&P 500 can be considered fairly priced for a weak but not recessionary economy, with a gradual normalization of real yields.
US Government Bonds:
Since the beginning of the year, there has been a phenomenon known as a "bull steepening" in US government bonds. Short-term yields have come down due to expectations of future rate cuts by the Federal Reserve (Fed), while long-term yields have remained relatively constant. This has resulted in underperformance of cyclical stocks, as the consensus view is that GDP growth is weakening but not collapsing.
However, it is important to exercise caution, as the recession playbook suggests that a persistent yield curve inversion can last for 10 to 27 months. Currently, the yield curve is still inverted, and the labour market has not turned recessionary. While the soft landing viewpoint is popular, it is essential to consider the historical duration of macro lags.
Conclusion:
Despite the rally in US equity markets and new all-time highs, not much has changed since the end of 2023 in terms of US real GDP growth, labour market trends, and inflation. The Federal Reserve is expected to proactively cut rates in 2024 to support the economy. The most pressing questions are when they will start and how fast they will go.
In summary, the bearish narrative surrounding bonds and equities may seem tempting, but considering the economic indicators, it appears to be just noise. As long as there is orderly disinflationary growth, proactive rate cuts, and low but not negative growth, the markets can expect a comfortable and predictable outcome.
Disclaimer: The information provided in this blog post is for informational purposes only and should not be considered as financial advice.