Revisiting Short-Duration Stocks

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.

• 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.

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.

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.