February view from the EDGE®
▶ US stocks: Despite January’s plunge in stock prices, the S&P 500 Index, comprised mostly of large-cap growth stocks, remains heavily overvalued on our gauge. The Federal Reserve Board recently announced that it would add further monetary stimulus through at least March leaving its federal funds rate near zero and continuing to expand its balance sheet, providing further support for the stock market. and the short-term economy. However, the Fed has raised the prospect of policy tightening for a yet-to-be-determined period beginning in March at the earliest if inflation remains high and unemployment low. Although our measures of the slope of the yield curve are steep enough to support the equity market, widening credit spreads can serve as a harbinger of an economic slowdown. Additionally, investor psychology has turned less positive given the recent break in the market’s persistent uptrend since March 2020, also weighing on the outlook for US equities. As inflation has risen far more than expected and far beyond current interest rate levels, the potential for an abrupt shift in policy from the Fed for a stronger response to the fight against the inflation could trigger a more severe stock market correction. In a rising rate environment, higher quality and/or value-oriented stocks may outperform.
▶ European equities: Inflationary pressure remains high across Europe as the latest inflation figure hit a record high. Concerns over the potential for the ECB to take more aggressive action in response to inflationary pressures than currently expected by market participants could prove a headwind for European equities. In addition, the continued widening of investment grade and high yield credit spreads is indicative of concern. Overall, a negative outlook remains.
▶ Japanese stocks: The potential for a return to a more positive outlook exists as we see credit spreads tightening in the region. However, investor psychology indicators show a more negative short-term outlook. Overall, this combination of factors contributes to an overall negative outlook for Japanese equities in the near term.
▶ Chinese stocks: Yield curve flattening measures for the region, coupled with negative investor psychology, continue to weigh on the near-term outlook for Chinese equities. A significant tightening of credit spreads accompanied by yield curve steepening measures would help improve the environment for Chinese equities. However, the outlook for Chinese equities currently remains negative.
▶ Indian stocks: Recent concerns about the impacts of a widening TED spread in India (a measure of available liquidity in a financial system measured as the difference between the interest rate that banks charge each other and the rate of short-term interest and risk-free government debt) may have declined. Additionally, the yield curve metric for the region has continued to steepen, which bodes well for future growth prospects. Overall, the outlook for Indian equities remains positive.
Fixed income securities and real assets:
▶ Obligations : Inflationary pressures and negative real interest rates continue to threaten income from holding bonds, while at the same time rising interest rates weigh on the value of bond holdings through depreciating prices . Research continues to favor US Treasury inflation-protected securities (TIPS) as well as floating rate US Treasury securities, which can perform well in an inflationary and rising rate environment.
▶ Credit: The outlook for credit remains negative as the risk of a continued widening of credit spreads would most likely reduce the value of core corporate debt.
▶ Gold: The recent rise in nominal interest rates has been more than offset by a similar rise in real rates, a negative factor for gold in the short term. However, gold remains attractive over the long term and is supported by the continuation of the current environment of negative real interest rates (nominal interest rates minus expected inflation). Growing geopolitical uncertainty and inflationary pressures globally highlight the role of gold in a diversified portfolio as a hedge. Overall, the outlook remains positive.
▶ Amenities: Commodities remain relatively undervalued in our research model and attractive over the longer term. Economic growth measures suggest a positive outlook; however, concerns over widening credit spreads in the US could be a headwind in the near term. Overall, commodities maintain a positive outlook.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.