Why the US outlook is ‘fragile’ and investors should take a defensive stance, in six charts

Why the US outlook is ‘fragile’ and investors should take a defensive stance, in six charts

Written by Vivian Le Chen

Adam Hitz, global head of multi-asset investing at Janus Henderson Investors, said the widening range of potential economic outcomes means that “the long-awaited soft landing has become less certain.”

With an apparently resilient US economy, Denver-based Janus Henderson Investors is seeing signs of a potentially more fragile environment than many in the financial markets realize. Perhaps the strongest signal that the US economy is facing headwinds can be found in the composition of the 10-year Treasury yield BX:TMUBMUSD10Y, which includes a “meteoric” rise in the adjusted or real yield. This real yield is about 2.5% and represents the highest cost of capital that US companies and households have faced in more than a decade, according to Adam Hitz, portfolio manager and global head of multi-asset investing at Janus Henderson.

Real yields reflect the reported yield on long-term Treasury securities after adjusting for inflation. Higher real returns are good for savers and generally push more investors into cash-like instruments, while making riskier options like stocks less attractive. It’s a big factor behind the recent surge in the 10-year nominal yield, which rose 5% in October and was trading at about 4.6% on Tuesday.

“Most importantly, nominal yields have continued to rise even as inflation has declined,” Hitz wrote in a commentary distributed Tuesday and posted on his company’s website. “We interpret this as an acknowledgment of a potential systemic change in interest rates.” Janus Henderson, who manages $308.3 billion in assets, is not the only big name to suggest that the US economy may be more fragile than it appears. In late October, Pershing Square’s Bill Ackman said that “the economy is slowing faster than recent data indicates,” and Bill Gross, co-founder of fixed-income investment giant Pacific Investment Management, said he expects a recession by next year. end. In the case of Janus Henderson, the company recommends investors “prioritize high-quality companies that are able to generate stable cash flows and possess sound financials as we enter the later stages” of the current cycle. Here are more reasons why Hitz sees fading hopes for a soft landing for the US economy and what investors can do about it.

Personal savings are dwindling

“The inflation in personal savings due to pandemic-era stimulus packages has largely come to an end,” according to Hitz. “Moreover, consumption has recently become fueled by credit cards. With borrowing costs reset to their highest levels in more than a decade, we question the willingness or ability of American households to continue to increase such purchases.”

Rates are higher for longer in a lot of places

Another reason for doubt about the durability of consumption is “our long-held view that interest rates will remain high for longer,” Hitz wrote, with expectations for a central bank pivot in 2024 waning. “Further exacerbating this risk is our belief that the U.S. economy will “And other economies, for that matter – have not yet felt the full brunt of the previous interest rate hikes.” “Relative to other tightening cycles, we are still in the fairly early stages, which means that the demand reduction that is the goal of tightening policy is still working its way through the system.”

Reasons to stay defensive

Unlike fixed income, which has been subject to repeated rounds of aggressive sell-offs, low-quality corporate bonds have yet to reflect the myriad of risks posed by rising interest rates. The spread between high-yield companies and those with risk-free standards “remains below long-term averages,” Hites wrote. “Our concerns about this sector are compounded by the risk of a harder-than-expected downturn, which could put pressure on some of these companies’ leveraged business models.”

Stock returns, decomposed

The risks from higher interest rates and a harder-than-expected economic “downhill” are not evenly distributed across stocks, with large technology and internet companies holding up better than the broader market. “In our view, many of these business models are well positioned to weather the economic downturn given their consistent cash flow generation, strong balance sheets, and exposure to enduring secular themes,” Hitz said. “On the other hand, value and cyclically exposed names could come under additional pressure as the economy slows.”

Diversification

Uncertainty about how long interest rates will remain high, coupled with geopolitical risks, is clouding the outlook, creating market volatility. This volatility and uncertainty causes asset classes like stocks and bonds to sometimes move in tandem. Bonds “have the potential to act as a ballast to riskier assets in a broad portfolio,” Hites said. On the one hand, yields have reached levels that offer attractive income potential and volatility may reduce if rates remain within current ranges. On the other hand, if rapid economic weakness forces central banks to pivot, which is not Janus-Henderson’s base case, “the potential for capital appreciation on bonds could offset losses in more cyclical asset classes.” In short, bonds are relatively more attractive. , with the potential to produce income and “generate capital” in a risk-averse scenario.

As of afternoon trading in New York on Tuesday, all three major stock indexes DJIA SPX COMP were higher as fixed-income investors seeking stability sent 30-year Treasury yields BX:TMUBMUSD30Y lower.

-Vivian Le Chen

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07-23-11 1232ET

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