Equity markets ignore ‘laundry list’ of risks, strategist says

Equity markets are ignoring a “laundry list” of potential risks in their latest bull run, and a major downturn could be coming, according to Julian Howard, investment director of multi-asset solutions at GAM Investments.

Despite the risks associated with a sharp rise in interest rates over the past 15 months, technology stocks in particular have led the charge so far this year as investors rushed to gain exposure to the AI ​​boom.

The Nasdaq 100 ended Friday’s session up 33% on the year, while the S&P 500 is up more than 11% and the pan-European Stoxx 600 is down just under 9%.

Still, in light of the latest round of economic data, economists are starting to raise the likelihood of further rate hikes from the US Federal Reserve, with the US economy and labor market remaining resilient, while core inflation is proving to hold firmer than expected.

Howard told CNBC’s “Squawk Box Europe” on Monday that, in light of this risk, the Nasdaq was “very expensive” at the moment and that now is the time for investors to “wait it out rather than get heavily involved in this market . “

“There’s this laundry list of issues and interest rates and inflation haven’t gone away. The debt ceiling is done and I think there’s a sense that the markets actually need to refocus on inflation and interest rates,” Howard said.

“The American consumer is quite ambivalent about inflation, it kind of expects higher inflation now, and that’s dangerous because it anchors higher inflation itself, because expectations obviously lead to higher inflation.”

Further increases in borrowing costs will also increase discount rates – a metric used by Wall Street to value stocks by determining the value of future earnings. This does not bode well for the technology stocks that have been driving much of the recent momentum behind US stock markets, as higher discount rates typically lead to lower future cash flow.

The Fed has raised benchmark interest rates 10 times since March 2022 in an effort to combat stubbornly high inflation.

Some Fed policymakers in recent weeks had expressed a willingness to pause the cycle of rate hikes at the central bank’s June meeting, and the market is now pricing in about an 80% chance of that outcome, according to the CME Group FedWatch tool. However, several Fed officials and economists have suggested that further monetary tightening may be needed later in the year.

“This AI technology trade started to fade in the latter half of last week and I think it may continue because if you think about it, long-dated assets like technology stocks are the most sensitive to the price of money, to the prevailing discount rate,” Howard said .

“If that discount rate starts ticking up because investors feel that the Fed isn’t actually done after all, then we could have a pretty significant correction, so we’re just a little cautious there in terms of the next few weeks and months.”

GAM sees a bleak long-term macroeconomic picture across major economies, with secular stagnation as a starting point. It believes the “Goldilocks” environment for stocks that has prevailed since October is no longer sustainable.

Although at odds with much of the consensus on Wall Street, Morgan Stanley also predicted in a research note last week that lower real and nominal growth in the US will lead to sharp downgrades of earnings forecasts, putting the brakes on the state’s stock rally.

The Wall Street giant expects earnings per share to be around 16% below both last year’s results and current 2023 consensus, before picking up again in 2024.

Morgan Stanley strategists said a number of “big picture” indicators continued to recommend investors take a “defensive stance.”

“Our US cycle indicator, bank lending ratio, yield curve, commodity prices, indices of leading economic indicators and the unemployment rate all point to worse than average forward returns on stocks, and better than average returns on high-quality bonds,” they said.