Navigating the Markets: February 12th, 2024
- Avantia
- Feb 11, 2024
- 3 min read
Updated: Mar 23
High-Quality Fixed Income – Overweight duration
Rate expectations have made a major shift this past week as one can see by comparing the CME FedWatch tool chart from last week with this week (below). This indicates that short-term rates are likely to come down later than expected and less than expected between now and September 18th. Our perspective is that the Fed could be influenced by the "long and variable lags" problem, which is a known issue related to the data they depend on, despite their "data dependence" policy.
High Yield Fixed Income – Overweight credit
Default rates have fallen to 2.08% in January, and are now well below the 25-year average of 3.00%. We do not expect defaults to rise much in the near term. This is because CCC-rated debt historically has the highest default rate and it now represents a much smaller portion of the high-yield universe. Beyond the long-run average since most companies refinanced their debt to long-term low rates and have limited debt maturities in the next year. It makes sense then that spreads have continued to tighten and are now at 3.38%.
Also, delinquency rates, which are seen as a leading indicator of defaults, have risen over the past several quarters but remain very low at 1.32%. We should receive an update to this data in mid-February. We remain overweight given the mix of low default risk, higher yield, and low delinquency rates.
US Equities – Underweight, tilt toward small-cap value
Equities sustained their upward momentum for a fifth consecutive week, with the S&P 500 Index hitting new highs and surpassing the 5,000-point milestone. Despite the Federal Reserve's pivot pause, investors focused on positive economic data and earnings reports.
Earnings season, initially uncertain, has transformed into a solid performance. With nearly 60% of S&P 500 companies reporting, the average earnings surprise rose to almost 4%, inching closer to the 6 – 7% long-term average. Excluding financials, the impressive average upside earnings surprise stands at over 6%.
The American Association of Individual Investors (AAII) survey reflects robust investor sentiment, with bullish attitudes approaching 50%, compared to 28% neutral and 22% bearish sentiments. This optimism, rooted in strong market fundamentals, highlights the positive outlook within the investor community.
International Developed Equities – Overweight, tilt toward Japan
Almost every sector of MSCI EAFE is currently trading at a discount relative to the long-term average. Meanwhile, buyback yields, which have been low historically, are now catching up to those in the U.S. which presents interesting investment opportunities. This is also extending to Japan where the number of buybacks has increased significantly showing that Japanese companies are focusing more on their shareholders. The P/E ratio for the MSCI ACWI ex-US index is 13.0x as of January 31st. This represents a 34.2% discount to the S&P 500 after one corrects for the natural discount of the MSCI ACWI Ex-US to the S&P500.
Japan appears to be poised to outperform in the years ahead as their P/E is historically low and the government is enacting policies that are likely to raise the profitability of companies. We also believe the US dollar will continue to fall and provide a positive tailwind for non-dollar assets.
Emerging Markets – Neutral, underweight China, overweight Korea, Mexico, India
Emerging market equities bring increased risk and volatility, but potentially strong returns in the long run. Currently, PE ratios are in line with the long-run average. However, China, Mexico, India, and Korea bring unique challenges and opportunities. China is in the midst of a property collapse and may see additional national stimulus to help its economy. This country represents between 25 and 30% of the index. On the other hand, Mexico is well positioned geographically to pick up much of the "nearshoring" investment opportunities as US companies reduce their exposure to China.
