Investment in a minute
4 min read 3 Nov 22
2022 has been a rates story. Most recently, the move in the long-end of the U.S. treasury curve caught our attention and increased our conviction to move long duration. From August 1st to October 24th, the yield on the U.S. 30y treasury increased by +146bp from 2.9% to 4.4%. The spread between the 5y and 30y treasuries narrowed from a heavily inverted - 0.45%, to +0.01%.
Our approach considers valuation and behavioural inputs to identify potentially attractive investments. On market behaviour, the journey of investors holding 30y bonds has been painful and the price action leading up to October 24th appeared indicative of a behavioural Episode and reflected a contrarian entry point. On valuation, today’s 30y yields appears far more aligned with the economic reality that was the case twelve months ago. Consensus estimates for 2023 CPI are around 4%. If inflation falls into line more quickly towards the Fed’s 2% target level, a 2% real yield would then feel attractive.
Further, having moved this far, we would expect to see a return to the diversification properties of duration during any kind of U.S. recessionary narrative or geopolitical shock.
Equity markets have enjoyed a meaningful rally in the past few weeks. However, yesterday’s FOMC meeting has, at least in the short-term, seemingly poured cold water over any fresh hope of a Fed pivot. If the equity rally is to continue, there is a need to shrug off concerns over the impact of a ‘higher-for-longer’ Fed.
Meanwhile, Q3 U.S. corporate earnings haven’t necessarily provided a decisive answer to the earnings slowdown risk that many were looking for both this quarter and last quarter.
Limited visibility on earnings makes it hard to assess the strength of equity valuation signals which look cheap compared to 10y averages but could still be susceptible to earnings downgrades.
As such, it is hard to get truly excited about sizing up equity positions and instead would play to a more responsive and tactical approach to further bouts of equity market volatility.
The Fed has been front and centre all year and that seems unlikely to change any time soon. With the next FOMC meeting not until December 14th-15th, the focus will continue to be on those data points that could sway the path of FOMC policy such as falling inflation data with the next CPI release in November next week or any signs of a cooling in labour market data. While, as an approach, we don’t seek to forecast such data nor directly trade such data releases, we often find the price reaction of different markets instructive in assessing behavioural biases in the market.
Outside of that, we’re keeping a continue eye on potential Episodes stemming from any specific domestically led volatility such as recently in China or the U.K.
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