Equity Investors Should Mind These Macro Drivers

November 23, 2023

2 minute read

by Tokufumi Sato, Ph.D., Portfolio Manager, Neuberger Berman

In this challenging environment, filtering meaningful market signals means paying close attention to the interplay among long-term rates, nominal growth and liquidity.

The dynamics of the equity market are influenced by myriad macroeconomic variables. Recently, long-term interest rates have served as a cap on performance, while nominal growth and overall liquidity have provided a floor.

Where might things go from here?

Start with rates. In the near-term, we believe higher long-term rates will continue to weigh on markets. In recent weeks, we have observed a strong correlation between stocks and long-term yields. If major central banks maintain their “higher-for-longer” stance, lower-quality and small-capitalization equities could face additional pressure. We believe this potential scenario suggests there may be a benefit to tilting toward quality within equity and fixed income portfolios.

Over the longer term, we believe rates will be swayed by a slew of factors, including Treasury bond issuance, quantitative tightening (QT) by the Federal Reserve, increased volatility, fiscal sustainability concerns, and policy normalization by the Bank of Japan—all of which could lead to a higher term premium. With annual deficits projected at approximately $1.7-$1.8 trillion, the U.S. Treasury Borrowing Advisory Committee has underscored the correlation between fiscal sustainability and the term premium, hinting that increased government bond issuance could dampen equity markets into 2024.

The growth picture also looks potentially challenging. We believe nominal growth may decelerate for a host of factors—including weaker consumer spending, a tepid recovery in China, and general geopolitical fragility.

As for liquidity conditions, we think reserves will remain at the current level, as the Fed’s Reverse Repurchase Program is set to decline as QT progresses. Given the ongoing rate of QT, a more stable reserve level ($2-$2.5 trillion, or 8-10% of GDP) looks in sight by the end of 2025.

Meanwhile, a mountain of cash is sitting on the sideline: U.S. money market funds now hold approximately $6 trillion. If the market is convinced that the Federal Reserve will begin to cut rates, this money could potentially flood the market with liquidity.

In this challenging market environment, we believe minding key macroeconomic drivers—specifically the interplay among long-term rates, nominal growth and liquidity—remains crucial to making well-informed investment decisions.