by Jeffey Kleintop, Chief Global Strategist, Charles Schwab & Company Ltd.
Although central banks may be near the end of the rate hike cycle, short-duration stocks may still be an attractive investment theme should interest rates remain at higher levels.
Short-duration stocks have outperformed consistently until March
Source: Charles Schwab, FactSet data as of 4/1/2023.
Low price to cash flow = bottom 20% of stocks ranked by price to cash flow in MSCI World Index. Performance relative to MSCI World Index. Past performance is no guarantee of future returns.
Short duration defined
Since interest rates began to climb in August 2020, investors have favored companies with stronger near-term cashflows. This was the opposite of the investing cycle of 2009-2020 when companies with little to no earnings or cashflow were the among the best performers, due to abundant low-cost funding.
What's next?
- Should interest rates take a dive in response to a deeper global recession where central banks are forced to cut rates aggressively back toward zero, we may return to an environment of cheap capital that could power outperformance of long-duration stocks.
- Alternatively, if central banks merely stop hiking and hold rates steady (or cut marginally) at relatively elevated levels, then short-duration stocks may resume their outperformance.
Short-duration stocks outperformed in March with the exception of 10 days when banking troubles hit markets, fueling uncertainty as to the direction of the global economy and central bank activity. While the extent of the fallout on lending from the bank stress is still unknown, central bank officials in the U.S. have expressed no concern that the collapse of Silicon Valley Bank and Signature Bank would lead to broader systemic risk. With the help of the Swiss Central Bank, the long-troubled Credit Suisse was rescued by UBS. In the absence of additional financial instability, central banks might not engage in rapid and aggressive rate cuts later this year as inflation remains well above target levels. Since March 17, short-duration stocks were back to outperforming the overall market.
Central bank outlook
The net number of central banks hiking rates has been trending lower (as you can see in the chart below), but no major central banks have supported an outlook for rate cuts this year. However, the futures market has priced in about 75 bps of rate cuts by the end of the year for the U.S., 50 bps for Canada, and 25 bps for Australia. If the market moves to price in even more rate cuts, short-duration stocks could lag.
Past the peak but not entering a valley
Source: Charles Schwab, Bloomberg data as of 4/4/2023.
Based on study of 76 central banks.
Market rapidly reconsidered year-end policy rates during March
Source: Charles Schwab, Bloomberg data as of 4/4/2023.
Not just rates
The global outlook remains uncertain–while growth and inflation are likely to moderate in coming months, how fast and how far is unknown, Historically, after spiking higher, inflation has eased in wave like patterns–easing and rising again. Markets could remain volatile if inflation follows this wave pattern, which could result in higher-quality, short-duration stocks outperforming.
Michelle Gibley, CFA®, Director of International Research, and Heather O'Leary, Senior Global Investment Research Analyst, contributed to this report.
Copyright © Charles Schwab & Company Ltd.