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Welcome to RBC’s Markets in Motion podcast. I’m Lori Calvasina, Head of US Equity Strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers.
In our latest podcast, we’re taking a break from earnings and highlighted two of the more interesting inbound client questions that we got over the past week, as well as some work we’ve done on how the stock market is trading in regards to supply chains. All of these speak to the strange resilience of the US equity market recently.
The big things you need to know: First, US equities tend to outperform bonds during Fed hiking cycles. Second, negative real yields remain supportive of US equities for now. Third, the recent peak in freight rates helped put a bottom in the S&P 500 and re-ignite cyclicals. If you’d like to hear more, here’s another five minutes. While you’re waiting, a quick reminder that you can subscribe to this podcast on Apple, Spotify and other major podcast providers.
Now, here are the details.
- Takeaway #1, US equities tend to outperform bonds during Fed hiking cycles.
- One of the more interesting client requests that we got last week asked about how US equities perform relative to other asset classes during Fed hiking cycles.
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- The relationship between commodities and US equities has actually been inconsistent.
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- And US equities tend to lag non-US equities, particularly early on in the hiking cycle.
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- But bonds are a different story. US equities tend to outperform bonds - Treasuries, Investment Grade, and High Yield - which isn’t surprising as a rising interest rate environment should theoretically push bond prices downwards naturally.
- This is an important part of the historical playbook to keep in mind in the year ahead. US equities have looked over owned relative to fixed income in just about every cross asset ownership study that we run (household balance sheets, tactical asset allocation funds). But it doesn’t look to us like Fed hikes themselves provide an incentive to reduce that exposure.
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- Takeaway #2, negative real yields remain supportive of US equities for now.
- Another interesting question that came into our team last week was on how US equities perform in different real yield environments.
- We kept things simple and looked at S&P 500 performance, post Financial Crisis, when real yields are increasing and decreasing, and when they are positive and negative. For context, we are currently experiencing some of the most negative real yields we’ve seen since the Financial Crisis, and they’ve been falling/moving sideways of late.
- On a 3, 6, and 12 month forward basis, equity market returns have been much stronger when real yields are falling and negative, than when they are rising and positive.
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- Takeaway #3, the recent peak in freight rates helped put a bottom in the S&P 500 and re-ignite cyclicals.
- After a massive surge higher, freight rates have been declining for the past five weeks. When they peaked, the S&P 500 put in what, for now at least, was its recent low.
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- As freight rates peaked and the broader market bottomed, Cyclicals also took off relative to both Secular Growth and Defensives.
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- Industrials, Materials, and Consumer Discretionary (ex internet) – all at the epicenter of the supply chain problem -- began to outperform the broader market.
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- At the same time, TIMT – Tech, Internet, Media and Telecom - began to lag. To be fair, some of the TIMT underperformance has also been due to misses on 3Q results related to supply chains which seemed to catch investors off guard.
- Supply chains are a complicated issue, and freight rates aren’t the only issue to monitor. Labor, ports, semis are just a few of the other variables that matter. It’s possible that mounting supply chain worries will trip up US equity markets again.
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- We’ve increasingly started to talk about year-ahead outlook season, which kicks off in late December and lasts through January and February, as a potential stumbling block for the stock market if investors start to worry that mid 2022 improvement in supply chains (the base case expectation of many investors, based on our late September survey work) isn’t realistic.
- But we still think it’s important to take a moment to listen to what the market itself has been telling us over the past month or so: US equity markets seem inclined to latch on to any glimmers of hope on the supply chain problem that they can find, and by the time it’s clear that the supply chain problem is well on its way to being fixed, the stock market will most likely have already baked in that outcome.
That’s all for now. Thanks for listening. If you’re interested in hearing from other RBC analysts on industry specific takeaways, be sure to check out our sister podcast, RBC’s Industries in Motion.