The S&P 500 index almost exited its longest bear market in decades on Friday. Everything’s okay now. Right?
Maybe not. Even if the Federal Reserve skips an interest rate hike at its June 13-14 meeting and opts to pause awhile to give 5% benchmark rates more time to slow the economy and reduce inflation, stocks and bonds still face many challenges.
“I’m aggressively neutral on our equity outlook,” said Elizabeth Burton, chief investment strategist in client solutions and capital markets at Goldman Sachs Asset Management, in a phone interview Friday.
“Our forecast is still 4,000 on the S&P 500, about a 6.5% drop from current levels.”
Burton pointed to negative equity fund flows this year, with investors instead favoring fixed-income investments with the highest yields in years, as a key reason for her unwavering stance on stocks this year, but also negative earnings growth and other headwinds she expects to persist this year.
“I think the risks are not over,” Burton said. In addition to persistently high inflation and pressure on commercial real-estate from tighter credit, there’s also a potential liquidity drain in store as the Treasury unleashes a deluge of bill issuance to reload its coffers drained by the debt-ceiling battle.
Plus, the craze around artificial intelligence has slightly more than a fist-full a companies responsible for most of the recent gains in the stock market.
“If you run a dog biscuit company, and mention you are incorporating AI, you might get a boost to your stock,” she said.
Congress voted Thursday to leave the U.S debt ceiling uncapped for two years, taking the threat of a default, and cataclysm in global financial markets, off the table for now.
But there’s still the up to $1 trillion in Treasury issuance looming this summer as a potential problem for markets.
Mom and pop might be thrilled by 5.4% yields on 3-month Treasury bills TMUBMUSD03M, 5.374%, instead of leaving cash parked in a bank savings account. The tradeoff is higher rates mean companies no longer have access to extremely cheap debt to buyback stock.
It also means a bigger burden for the U.S. government to service low-rate debt that matures. The Congressional Budget Office in May projected interest costs on public debt to reach $645 billion this year and hit $1.4 trillion in 2033.
“The debt ceiling was going to be the gift that keeps giving for awhile,” Gennadiy Goldberg, U.S. interest rate strategist at TD Securities, told MarketWatch.
“It’s going to be a record amount of bill supply outside of a crisis,” he said, adding that he expects the Treasury to look to build its cash balance back to about $600 billion in a few short months.
A growing worry is the flood of supply could drain reserves from the financial system, particularly even shock markets to a degree that forces the Fed to end its balance sheet reduction program early.
“Reserves are really worth keeping an eye on,” Goldberg said. “They are really what keeps the financial system spinning.”
Pause, cut, maybe
It’s tough to settle on what to make of this economy. The labor market remains extremely strong, stocks are rallying, but inflation remains stuck well above the Fed’s 2% annual target.
“There are a fair amount of signs that things are slowing, and will continue to slow, which would push toward a pause,” on Fed rate hikes, said Eric Stein, chief investment officer for fixed income at Morgan Stanley Investment Management.
“We’ve had 500 basis points of tightening in roughly 15 months,” he said. That’s a lot of tightening, and it’s going to take time to work through the system.”
So where do things stand for markets? It depends where you look for answers. “The stock market seems to be saying the economy is good,” Stein said. But the inverted Treasury yield curve also warns of recession, he said, with bond-market investors expecting at least some rate cuts will be used to prop up a wobbling economy.
If that happens, a 10-year Treasury yield TMUBMUSD10Y, 3.699% of 3.7% as of Friday, locked in for a decade, looks a lot more attractive than its 1.5% yield during the lows seen during the pandemic.
The S&P 500 index SPX, +1.45% made a run at exiting bear-market territory Friday, but narrowly missed closing above the 4,292 level needed to satisfy the widely used definition of an exit, which requires closing 20% above its bear-market closing low. It finished the week 1.8% higher at 4,282.
The Dow Jones Industrial Average DJIA, +2.12% rose 701 points Friday, adding to its 2% weekly gain, while the Nasdaq Composite Index COMP, +1.07% gained 1.1% Friday, for a 2% weekly advanced, according to FactSet.
U.S. economic data on tap for the week ahead includes manufacturing and services data on Monday, trade deficit and consumer credit data Wednesday and weekly jobless claims Thursday.