Despite their positive run so far, the US equities rally looks set to subside in the second half of the year as earnings soften and financial conditions tighten, warns State Street Global Advisors (SSGA) chief investment strategist Gaurav Mallik… although Europe looks to be in a stronger position, while fixed income could be making a comeback.
“Equities have had a broadly positive run in 2023, notwithstanding the banking sector crisis that pressured markets in March,” said Mallik in the firm’s mid-year global economic outlook.
“Equity performance has been supported by lower market rates, which have partially offset weaker corporate earnings. However, we do not see the rally in equities being able to sustain itself through the remainder of 2023.”
The equity market in the US has benefited from the recent drop in rates, alongside a collection of mega-cap stocks that saw earnings beat lowered expectations, driving an advance over recent months.
However, with earnings expected to soften over the rest of the year – and with worsening fundamentals, weaker demand and tighter financial conditions squeezing liquidity, concerns are growing that the current momentum is unsustainable. SSGA also notes the challenge of elevated margin pressures driven by continued high inflation.
“We do not see the rally in equities being able to sustain itself through the remainder of 2023.”
“We have a more constructive view on European equities, where we favour an overweight allocation,” said Mallik. “European earnings and sales expectations continue to surprise on the upside, and the region’s markets offer a significant discount to US equities. We also believe that a modest inflationary environment is beneficial for value assets, and Europe has a relatively greater proportion of these within market indexes.”
Overall, the US dollar looks to be in transition from a bull market to a bear market. However: “The transition will be inconsistent, and volatile, and may take the better part of a year,” thinks Aaron R Hurd, senior portfolio manager at SSGA.
“The USD was supercharged in 2022 by a combination of rising relative yields and its appeal as a safe haven destination amid falling equity markets, rising recession risk, and high geopolitical tension. By our estimates, the USD peaked in September 2022 at 29% above fair value relative to an MSCI World ex USA Index currency basket. That overvaluation is now down to 20%, as of April 2023, with plenty of room to decline further as the factors justifying an expensive USD are reversing.”
Meanwhile, SSGA reccommends that investors should watch fixed income as it may present better return potential than equities.
“Value has been building in bonds over the last couple of years,” said Matt Nest, head of active global fixed income. “Overall, we find more opportunity in fixed income than we have for several quarters… We maintain a cautious stance towards credit, owning higher quality, lower beta instruments, and a preference for investment grade over high yield.”
In other news, it looks as if investors may finally be growing less defensive. The State Street Risk Appetite Index for June indicates that institutional investors continue to reduce their exposure to risk assets, but the extent of this defensive behaviour has moderated during the past month.
“This gradual thaw in behaviour centres on a preference for emerging markets, improvements in cyclical versus defensive equity flows, and renewed demand for high yield fixed income,” said Dwyfor Evans, head of APAC Macro Strategy at SSGA.
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