Equity markets like lower bond yields because companies can borrow money more cheaply, which can be used, for example, to buy back shares or take over another business at a premium. It also makes bonds a less attractive competitor for investor assets relative to stocks. For much of the past 15 years, falling bond yields have accompanied higher stock valuations and prices. Now this process may be working in reverse.
From the beginning of 2024 to March 28, U.S. equities rallied 10.6 per cent despite faltering hopes for Federal Reserve rate cuts. More recently, however, the S&P 500 has become much more negatively affected by the expected persistence of higher rates.
The options market-implied forecast for year-end Federal Reserve policy rates (I like this measure better than economist forecasts because options investors have higher conviction – they are risking money in support of their view) spiked from 4.59 per cent on March 28 to 4.94 per cent now.
The current option-implied interest rate forecast is less than 40 basis points lower than the current effective Federal Reserve policy rate. Markets have thus gone from expecting five 25 basis point rate cuts at the end of 2023 to less than two.
Morgan Stanley chief investment officer Michael Wilson believes that the persistent U.S. economic growth that is keeping inflation pressures high is largely the result of government spending initiatives rather than a new, durable economic expansion. He remains cautious on early cycle, cyclical market sectors like small caps as a result.
Mr. Wilson lists the biggest investor risk as “higher back-end rates as the bond market begins to demand a higher term premium due to higher inflation.” In other words, investors might demand lower stock valuations if longer term risk-free bond yields hover near 5 per cent.
Morgan Stanley recommends higher quality stocks, those with low debt and reliable-if-not-spectacular profit growth, to combat expected volatility and the potential for economic growth to stall as fiscal spending fades. The strategist recently upgraded large cap energy stocks as a valuation-conscious way to benefit from current economic reflationary pressure.
Mr. Wilson maintains a concentrated Fresh Money Buy List of U.S. stocks he finds attractive. Currently these are Centerpoint Energy Inc., Coca-Cola Co., Colgate Palmolive Co., McDonald’s Corp., Mondelez International, SBA Communications, Verizon Communications and Walmart Inc.
– Scott Barlow, Globe and Mail market strategist
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The Rundown
After two years of watching portfolio values erode, many people are fed up – and nervous. One solution is to add some energy stocks to your list. Many offer both strong cash flow and an attractive total return, writes Gordon Pape.
Hedge funds have built up their biggest bet against the yen in 17 years, raising the prospect that when Japan’s embattled currency does rebound from its 34-year low against the dollar, the short-covering rally could be a powerful one. Reuters explains.
The mutual fund is now 100-years-old, writes Tim Shufelt. They remain exceptionally popular with Canadians. But the average everyday investor will pay hundreds of thousands of dollars in fees over their lifetimes if they rely on mutual funds. The baffling part is that they do so voluntarily.
Banks have begun coverage of Reddit after its recent IPO, but there are doubts about its user growth.
Others (for subscribers)
The most overbought and oversold stocks on the TSX
Monday’s analyst upgrades and downgrades
Globe Advisor
Why younger retirees should set up a RRIF
Why this money manager is buying Intact and selling Choice Properties REIT
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Ask Globe Investor
I own the Vanguard S&P 500 Index ETF (VFV). Is there a reason you like ZSP over VFV?
No. All the major ETF companies offer S&P 500 funds, and they are virtually identical in terms of their holdings, cost and performance. VFV’s annualized total return for the five years through March 31 was 14.95 per cent, compared with 14.97 per cent for ZSP and 14.94 per cent for the iShares Core S&P 500 Index ETF (XUS). These differences are so small as to be meaningless. All three of these ETFs also have identical management expense ratios of 0.09 per cent, which means only a sliver of your money will go toward fees. Keep in mind that ETF companies also offer currency-hedged versions of their S&P 500 funds for investors who want to be protected in the event of a sharp rise in the Canadian dollar. The downside is that, if the Canadian dollar falls, currency-hedged ETFs won’t get the same benefit as non-hedged ETFs. Also be aware that hedging is not an exact science, so the returns of a currency-neutral ETF might still differ from the returns of the U.S. index it tracks.
– John Heinzl
What’s up in the days ahead
Click here to see the Globe Investor earnings and economic news calendar.
Compiled by Globe Investor Staff