by Erik L. Knutzen, CFA, CAIA, Chief Investment Officer—Multi-Asset Class, Multi Asset Strategies – EMEA, Neuberger Berman
This time of year always makes me reflect on the intense seasonality of our business. As the calendar turns to September, investors return from vacation, news flow ramps up, progress versus objectives is assessed even as planning for the coming year kicks off, and markets reset themselves as liquidity begins to return.
It’s as if a starting gun fires to launch the sprint to year-end. But are we running the 100-meter dash, where the spoils go to those who barrel toward the finish line, or the 110-meter hurdles, where a series of obstacles can knock competitors off the track?
In advance of our Asset Allocation Committee meeting at the end of the month—where we will recalibrate our views for the coming six to 18 months—we try to answer that question by highlighting the key issues that we believe bear watching between now and the end of the year.
The Next Inflection
Let’s start with the macro dynamics and follow with the bottom-up.
We are looking for what we would describe as the next inflection or tipping point in the economy, and see three likely candidates. The first would be more decisive signs of slowing growth even as inflation remains stubbornly above policymaker targets, which could come to pass as higher oil prices exert secondary effects over the coming months. We are concerned that consumers might finally become exhausted by higher prices. And while the stock of central bank, corporate and consumer liquidity remains high, investors may be starting to focus on the flow, which has been negative for some time.
We are watching the deepening slowdown in China closely, as well as the attendant real estate stresses. That is a complex dynamic that is already weighing on global growth, but could also begin to spread disinflation.
The question of how and when the Bank of Japan will normalize its monetary policy remains prominent, particularly given the recent strengthening of the U.S. dollar against the yen. The answer could have a big impact on the volatility, not just of currencies, but of long-term bond yields worldwide.
We are watching real yields in the U.S., which are already pressing against their post-2008 highs, but have yet to dampen equity valuations. And we believe a higher term premium may be required to account for the challenges of fiscal dominance and debt sustainability—the risk that fiscal expansion fights against central banks’ efforts to curb inflation. We are on the lookout for evidence of the bond market beginning to price in that higher term premium.
Cracks in the Credit Market
From the bottom-up perspective, we will be watching earnings reports for signs that rising wages and interest costs are tightening margins at companies with high operating and financial leverage. These companies would be especially at risk from stagflation, as that would make it more difficult to pass costs on to consumers.
Similarly, we are looking out for cracks in the credit market as the high-yield maturity wall comes ever closer and the first policy rate cuts get priced further and further out, raising the threat of expensive refinancings. This is perhaps the most visible threat, and therefore one we think could be priced in sooner rather than later—a “canary in the coalmine” warning of broader market volatility.
At its last meeting, the Asset Allocation Committee moved its views broadly to neutral in the face of sharply conflicting signals from its short- and medium-term outlooks.
Given the several sources of potential volatility lurking between now and year-end, however, it is not surprising that these neutral views are defensive at the margins and will be assessed closely at our next Asset Allocation Committee meeting. We see hurdles ahead, not a straight dash.
In equity and credit, our defensive inclination means a more favorable view of high-quality companies, and especially those with plentiful free cash flow, high cash balances and less expensive longer-term debt. Even putting business conditions aside, these firms are currently earning far more on their cash than they are paying on the bonds they termed out before 2022. This view on quality also leads us to favor emerging markets debt over high yield.
The view on core government bonds is more complex and the subject of debate, both within our Multi-Asset team and between us and our colleagues in Fixed Income. Long-dated yields are at the top end of the range we have been forecasting for this year, making interest rate exposure more attractive—but demand for more term premium could cause long-term yields to be higher for longer.
Overall, it is fair to say that we are anticipating change. We find it increasingly difficult to imagine the persistence of recent market conditions. That seems appropriate for the time of year: Once the starting gun sounds, attention must be on the race in front of us, not the previous day’s qualifying heats.
In Case You Missed It
- Eurozone Producer Price Index: -7.6% year-over-year in July
- U.S. ISM Services Index: +1.8 to 54.5 in August
- Eurozone 2Q GDP: +0.5% year-over-year
- Japan 2Q GDP: +4.8% quarter-over-quarter (SAAR)
What to Watch For
- Wednesday, September 13:
- U.S. Consumer Price Index
- Thursday, September 14:
- U.S. Retail Sales
- U.S. Producer Price Index
- European Central Bank Policy Meeting
- Friday, September 15:
- University of Michigan Consumer Sentiment (Preliminary)
- Wednesday, September 13:
Investment Strategy Group
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