Market Update

February 21, 2023

Stocks suffer renewed declines

In this issue

• Stronger than expected growth and inflation data have bolstered the notion of “No Landing,” or a prolonged recalibration of the economy toward equilibrium. The process is not necessarily welcomed by investors as the expected policy rate path pushes higher while corporate profits continue to flounder.

• A jump higher in bond yields has put downward pressure on equity valuations, especially in more speculative segments, along with bond proxies. We prefer exposure to sources of quality, lower volatility and Growth at a Reasonable Price (“GARP”).

Equities insight

Mounting pressure from higher yields

Equities endured their worst trading day in over two months, driven in large part due to a burst higher in bond yields, as the S&P 500 declined nearly 2%. Losses were broad but concentrated in many segments that had enjoyed leadership to begin the year, including sources lower in quality, less profitable and higher in perceived duration. As bond yields increasingly reflect a “higher for longer” interest rate regime and corporate profits continue to move lower, we expect equity volatility to persist.

What to know:

• Investors are digesting recent macro data that indicate economic growth and inflation remain firmer than expected given the efforts of policymakers to cool imbalances. This has propelled the notion of “No Landing,” or a prolonged recalibration of the economy toward equilibrium rather than a soft landing. As a result, expectations for policy rates have increased.
• Faster nominal growth has become a double-edged sword for markets. A shift in composition from the goods-based portion of the economy to services offers less reprieve for corporate profits, which have slid into recession and are more tethered to manufacturing. Sticky sources of service inflation provide more reason for policymakers to maintain rates higher for longer.
• Stock valuations tend to be influenced by bond yields. With treasury yields having moved sharply higher in recent weeks, stock valuations increasingly appear extended, in our view. The S&P 500 equity risk premium, or relative value of stocks-to-bonds, is at its lowest level since 2010. More speculative segments of the market appear most vulnerable.

Investment implications:

• The risk/reward skew for the broader U.S. Large Cap index is not particularly attractive or unattractive, and we remain slightly underweight on a tactical basis. We would become more supportive at lower price points or if evidence built that nominal growth was on a sustainable trend toward equilibrium. In the interim, we find value underneath the surface with preferred exposure to quality, lower volatility and Growth at a Reasonable Price (“GARP”).


• We find opportunity in developed international equities given a compelling blend of value, yield and cyclical fundamental improvement. The region’s equity markets have strongly rallied and are vulnerable to a short-term pullback, but we’re more constructive on an intermediate-term basis.

Exhibit 1: Higher yields tend to put downward pressure on equity valuations

Source: FRIM Investment Research, Bloomberg. Weekly data from January 2010 through February 21, 2023.

Exhibit 2: Historically, rate-sensitive cyclicals perform well when rates rise

Source: FRIM Investment Research, Bloomberg. Weekly data from January 2010 through February 21, 2023.