How an Economic Slowdown Could Surprise the Market
We think investors have sometimes interpreted bad news for the economy as good news for stocks, hoping that a slowing economy would temper inflation and the Federal Reserve's rate hiking campaign. That interpretation may change soon.
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Key Points
What this is
Our analysis shows U.S. stocks appear overpriced as consumer spending may decline and interest rates may stay elevated.
Why it matters
If consumer spending declines, the economy and corporate earnings may decline as well, potentially hurting stock prices.
Where it's going
We are underweight stocks globally, favoring high yield bonds, natural resources and cash.
Global markets remain volatile, with equities starting the month lower before declining long rates toward the end of the month brought investors back to stocks. Interest rates fell as investors read the Federal Reserve’s communication as relatively dovish. Further, U.S. economic indicators have softened, including a somewhat weaker employment report for October. With equity prices above fair value in our opinion, we think bad news about the economy will no longer be considered good news about Fed rate moves, leading to our global underweight to stocks. Let’s take a closer look.
With the recent decline in interest rates, investors pulled forward their anticipated timing and increased the magnitude of expected rate cuts in 2024, based on the . However, we expect the Fed to keep rates elevated until it sees clear signals of a deteriorating labor market. We see some additional downside to longer term rates, but we are less convinced that downside will be cheered by equity investors. The market does not appear to be priced for a material slowdown in growth, and we see consumer spending slowing due to depleted savings and already higher credit card debt. For the two-thirds of Americans who are homeowners, however, real wage growth may be better than it appears as those consumers are not feeling the shelter inflation component of the Consumer Price Index to the same extent thanks to fixed rate mortgages. This suggests some potential durability of spending capacity to help offset pressure elsewhere.
In terms of other potential risks to the economy, the continues to heat up but it hasn’t ignited oil prices, which moved lower over the past month. We are monitoring the situation closely as an escalation that threatens oil supplies could negatively impact global growth. We also are monitoring any developments around potential U.S. government shutdown, including the potential for headline risk should it act as a catalyst for a downgrade of the U.S. debt rating, as well as some economic impact if prolonged. Macro trends outside the U.S. are already weak, with part of Europe appearing recessionary and an economic recovery in China remains elusive.
In our that guides Northern Trust portfolio allocation, we maintaining our relatively modest underweight to risk, including a global underweight to equities. We prefer high yield bonds to developed market equities, given attractive yields and high yield’s potential to limit losses if equity market fall. We also favor natural resources to emerging market equities and maintain an overweight to cash.
Federal funds futures are contracts used to hedge short-term interest rate risk. They reflect the market's insight on the future course of the Federal Reserve's policy rate.
The Global Policy Model is a Northern Trust Asset Management moderate-risk multi-asset portfolio with asset allocation based on our 12-month tactical market outlook. The model informs the tactical positioning of other NTAM models and portfolios with different risk profiles.
Main Point
Positioning for Less Risk-Taking
The market does not appear to be priced for a material slowdown in U.S. economic growth, and we see consumer spending slowing due to depleted savings and already higher credit card debt. With equity prices above fair value in our opinion, we think bad news about the economy will no longer be considered good news about Fed rate moves, leading to our global underweight to stocks.
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