Keeping Perspective

Markets have sprung to life in the early days of November. Since the start of the month, the 10-year Treasury yield has fallen roughly 25 basis points. Though spurred by a softer batch of economic data, lower bond yields have taken pressure off stocks. Over the same time frame, the S&P 500 rose just over 5%. In some ways, bad news has been good news. Still, it is important to keep perspective. Rates are in a long-term uptrend as the Fed does not yet believe inflation has been beaten. This increases the pressure on consumers and makes stock selection critical.

A weaker than expected October jobs report sent bond yields lower at the start of November. Economists were expecting the U.S. to add 170,000 jobs, but payrolls only increased by 150,000. Not only did the number come in below estimates, but it was also a sharp slowdown from the 297,000 jobs added in September. Ordinarily, markets would not cheer a softening labor market. However, in a world of sticky inflation, this equation has been turned on its head. A softer labor market supports the notion that inflation pressures are easing and the Fed will soon be able to end its aggressive interest rate hiking campaign.

This progress is welcomed, but the Fed does not seem totally convinced. In a recent commentary, Fed Chair Jerome Powell indicated that the committee was not confident it has done enough to bring inflation down. While acknowledging they can afford a more cautious approach, inflation still sits above the Fed’s target. Even if there are no further rate hikes, it is unlikely that policy will be anything but restrictive for some time. For consumers, this means that relief may still be further off. Elevated rates for mortgages, credit cards, auto, personal, and commercial loans will continue to take an economic toll. This is a risk that bears watching.

It is also important to view the recent pullback in rates in the context of a deteriorating fiscal environment for the U.S. government. Treasury issuance will continue to rise as the government pays for a slate of stimulus programs, entitlements and discretionary spending indexed to inflation, and higher interest expenses. Supply is on an upward trajectory at a time when many of the biggest buyers have left the market. The path of least resistance for rates is upward.

With all of this in mind, careful stock selection is imperative. Stocks that are relatively insensitive to macroeconomic swings with the ability to self-fund viable growth opportunities should be best positioned. To date, the mega-caps have best fit this narrative and it has been reflected in their performance. However, we believe there are similar opportunities further down the cap spectrum. We believe a focus on consistent growth and balance sheet quality will yield positive results.

Thanks,
Preston May, CBE®
Research Analyst