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Instead of the stagflationary ’70s, when the Fed was too easy & slow to fight inflation and too fast to back off, could the ’90s be a better analogy? It saw inflation start above 5%, slowly decelerate and hover around 3% for much of the period, with monetarist Greenspan keeping the target funds rate elevated around 5% over the decade’s back half. The S&P 500 nearly tripled in price over the 10 years and Bloomberg US Aggregate Bond Index annual returns roughly averaged 7%.

Much rides on the debt ceiling outcome but labor market data may matter more to the Fed. At this writing, April’s sticky core PCE and a robust consumer have futures pricing better than 50-50 odds of a quarter-point hike when policymakers meet in a few weeks. Reports on April job openings & the quit rate and May nonfarm payrolls & hourly earnings could change that. All are due this week. Also watching ISM reports for further weakness manufacturing.

We’ve added exposure to Growth through Small Caps in Domestic Equities but remain defensive overall with a heavy tilt toward Value/dividend payers. Internationally, we’re maintaining above-benchmark exposure to Developed & EM International in both Equities (on valuations) and Fixed Income (a play on the dollar and a near double-digit coupon in EM). Our biggest overweight is in MBS. Economic deterioration concerns have us staying underweight in Investment Grade (IG) and High Yield corporates on potential credit deterioration and wider spreads. With the 10-year Treasury yield near the top of its recent trading range, we have shifted slightly longer on duration. In Liquidity, we believe there’s a bias toward extending duration, i.e., moving out the curve.

What

Positioning

May 30, 2023

Weekly

October 2022

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Our fixed-income models are slightly longer than neutral duration and positioned for a steepening of the 5- to 30-year yield curve. As far as sectors, we remain underweight IG Corporates, High Yield and CMBS, and overweight MBS and EM. We expect company-specific results to drive corporates, including high yield, in a weakening earnings environment. We continue to recommend a small non-dollar overweight and to trade the U.S. dollar tactically. We think rumors of its demise as the world’s reserve currency are greatly exaggerated.

Fixed income

We continue to prefer defensive dividend-paying stocks and are underweight rate-sensitive growth stocks. We’re more constructive on international large cap and emerging markets, and in the U.S., also favor value and dividend-oriented equities while acknowledging the rally in riskier categories could portend some opportunities in the months ahead.

The mid-March failure of two large U.S. regional banks and the collapse of confidence in Credit Suisse contributed to the IMF lowering its global GDP growth forecast to 2.8% this year from 3.4% in 2022. The IMF sees the potential for growth to decelerate further to 2.5% (which would represent the third-slowest outcome since 2001) if stress in the financial sector deepens. Risks of accidents in financial markets have risen as the environment has shifted from extremely easy to somewhat restrictive monetary conditions. There is now awareness that something else could break. All eyes have been on the reopening of China, where GDP surprised to 4.5% year-over-year (y/y) in the first quarter, accelerating from 2.9% in the fourth quarter. The upside surprise was concentrated in retail sales, which grew 10.6% y/y in March vs. 3.5% in the year’s first two months, while industrial production was somewhat disappointing. Those details reinforced the view of a mainly domestically focused recovery, in line with the policymakers’ intentions and the design of stimulative measures. Momentum in Chinese economic activity is likely to remain sustained into second quarter, with limited spillover effects. But clouds continue to linger over the medium- to longer-term outlook on challenges with respect to demographics, productivity, the transition to a more advanced and sustainable growth model, and the prospect of an intensifying tech competition with the U.S.

April provided a convoluted narrative with support for a hard, soft or rocky landing in the months ahead. On the one hand, manufacturing and trucking activity softened, as did retail sales. But expenditures on services, travel and entertainment accelerated. After a late winter/early spring run-up, jobless claims plateaued but hit their highest level since the pandemic for workers earning more than $200K annually. At a below-consensus 1.1%, the initial take on first quarter GDP growth disappointed. But stripped of a big drawdown in inventories, which by March appeared to be ending, GDP grew a robust 3.4% over the quarter. And both core PCE and wages accelerated over the three months vs. fourth quarter, though the core pace slowed in March alone. The primary question remains how quickly the economy will cool, and what it will take for the Fed to pivot if May’s 25 basis-point hike is the last of the cycle. Inflation data overall continues to run hotter than the Fed wants, about double intended targets, and we believe they will keep rates higher for as long as is necessary, regardless of futures market signals and risk of a recession. As May begins with another bank rescue, we don’t see a bank crisis but do see stress as depositors find better yields elsewhere and smaller banks face declines in credit availability. It’s fair to say our base case for at least a technical recession in the second half is building momentum.

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Positioning

Developed international stocks gained in April as emerging markets gave ground. Europe has been driving international equity markets higher over recent weeks, with economic data surprisingly positive, particularly within services. There have been signs of earnings resilience from companies in the region, many of which have diversified global revenue streams. Meanwhile, volatility has declined sharply from March highs that followed the collapse of SVB and the bailout of Credit Suisse, but investors remain nervous, especially as elevated inflation lingers. Nevertheless, we are getting the sense that focus is starting to return toward company fundamentals after a long period in which markets have been driven by short-term factors.

Shaking off stubborn inflation and pockets of economic weakness, U.S. stocks rose slightly in April on better-than-expected earnings, particularly among big technology, consumer staples and bank names. The exception was small caps, with the Russell 2000 giving up nearly 2%, falling further behind mid and large caps for the year on underperformance in value names. Investor preference for growth continued, and volatility remained muted, reflecting continued expectations of an end to Fed tightening, hopes of a quick pivot and a general level of optimism we believe is premature. The dramatic improvement in stocks since the October low is of course welcome, but growth/tech valuations remain elevated. We believe that earnings will fall off through the year and the potential for a 10-12% grind lower is possible and a buying opportunity should it occur.

International Equity

April was a volatile month across fixed income sectors but positive for most, building on the first-quarter comeback for bonds. Fluctuating Treasury yields suggest that fixed income investors as a group are more convinced of the inevitability of a recession than equity investors. Concerns around banking stress and a debt-ceiling redux create a risk-off trend, causing yields to fall, while signs of persistent inflation and economic resilience produce the opposite effect. With the May 3 25 basis-point hike, the Fed now walks a fine line between supporting banks struggling with lower asset values and addressing still too high inflation. This tug of war has us cautious on duration—we just went slightly long, but have been there before this year and pulled back. The same dichotomy is driving our view of credit, more so in High Yield where we believe spreads have significant potential to widen.

Positioning

Source: Fred®, U.S. Treasury, Bloomberg

As of 4/28/2023 4.82% 4.35% 5.10% 5.06% 4.80% 1.04% 4.74%

Short-term yields SOFR 30-Day Avg 1-month T-Bill 3-Month T-Bill 6-Month T-Bill 1-year T-bill MMDA Avg First Tier IS Avg

Liquidity

iquidity

Source: Bloomberg

As of 4/28/2023 2.96% 3.01% 3.57% 2.51%

Total returns U.S. Aggregate Global Aggregate U.S. Corporate High Yield S&P Municipal Bond

Fixed Income

As of 4/28/2023 8.59 0.89 16.82 11.80 2.86

Total returns S&P 500 Russell 2000 NASDAQ MSCE EAFE MSCI EM

Equities

Percentages as of 5/04/2023 Source: Trading Economics.

Jobless Rate 3.50 6.60 5.30 2.80 3.80

Inflation 5.00 7.00 0.70 3.20 10.10

Interest Rate 5.25 3.75 3.65 -0.10 4.25

GDP QoQ 1.10 0.10 2.20 0.00 0.10

GDP YoY 1.60 1.30 4.50 0.40 0.60

Country United States Euro Area China Japan United Kingdom

Macro Dashboard—Inflation roiling developed markets

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Economies

Liquidity

Fixed Income

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Economies

May 2023

Monthly

Maintain a slightly longer duration than prior sentiment given changes in rate expectations, while also capitalizing on opportunities slightly further out the curve. Maintain a general preference for higher quality securities given risk of an economic slowdown. Take a more balanced approach to floating rate securities leading up to a Fed pause.

Relative to longer-term fixed income, the 0-3-year part of the yield curve is attractive. For now, investing incrementally shorter can be beneficial, but we are finding more attractive opportunities in the ultrashort space, particularly in higher quality securities.

Positioning

Fed funds futures continue to price in multiple rate cuts by year-end based on increased risk of recession from potentially tighter bank lending standards and 500 basis points of rate hikes in 14 months. We tend to agree more with the Fed that there is more work to be done on inflation and expect policymakers to keep rates elevated for longer, potentially implementing their first cut at year-end or first quarter 2024. In the wake of March’s regional bank failures, investors have been moving money from deposit accounts into money market portfolios. Total U.S. money fund assets increased by around $340 billion in March, among the largest inflows in history.

Percentages as of 5/04/2023 Source: Trading Economics.

Jobless 3.50 6.60 5.30 2.80 3.80

Inflation 5.00 7.00 0.70 3.20 10.10

Interest Rate 5.25 3.75 3.65 -0.10 4.25

GDP QoQ 1.10 0.10 2.20 0.00 0.10

GDP YoY 1.60 1.30 4.50 0.40 0.60

Country United States Euro Area China Japan United Kingdom

Macro Dashboard—Inflation roiling developed markets

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Source: Bloomberg

As of 4/28/2023 3.59% 3.46% 4.60% 2.39%

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International

April afforded a degree of calm in fixed income markets following the turmoil of March. While volatility subsided, attention once again gravitated toward central bank rate intentions as Pan-European inflation remained strong. This broadly weighed on sovereign bonds, with U.K. gilts being the notable underperformer, but didn’t deter both investment-grade and sub-investment-grade bonds from posting modest positive returns over the month. Elsewhere, emerging markets reported broadly positive returns, buttressed by the continuation of China’s rebound from its Covid-zero reopening and by strength in Latin America.

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Mortgage-Backed Securities

Our fixed-income models are neutral benchmark duration and positioned for a steepening of the 5- to 30-year yield curve. As far as sectors, we remain underweight IG Corporates, High Yield and CMBS, and overweight MBS and EM. We expect company-specific results to drive corporates, including high yield, in a weakening earnings environment. We continue to recommend a small non-dollar overweight and to trade the U.S. dollar tactically. We think rumors of its demise as the world’s reserve currency are greatly exaggerated.

Positioning

April was a volatile month across fixed income sectors but positive for most, building on the first quarter comeback for bonds. Fluctuating Treasury yields suggest that fixed income investors as a group are more convinced of the inevitability of a recession than equity investors. Concerns around banking stress and a debt-ceiling redux create a risk-off trend, causing yields to fall, while signs of persistent inflation and economic resilience produce the opposite effect. With the May 3 25 basis-point hike, the Fed now walks a fine line between supporting banks struggling with lower asset values and addressing still too high inflation. This tug of war has caused us to be neutral duration—we’re just not seeing enough conviction to adjust long (or short) at this point. The same dichotomy is driving our view of credit, more so in High Yield where we believe spreads have significant potential to widen.