We’ve been more optimistic than most about markets recently.
But in light of recent conditions, we’re getting more cautious. Stocks and crypto are starting to look shaky, and the conditions that made markets extra susceptible to “less bad” news are disappearing.
A lot has changed in the past few weeks, but here’s what’s caught our attention.
Rising bond yields. Part of the reason tech stocks and crypto have rallied so hard is because bond yields fell swiftly from October to January. The 10-year yield dropped from 4.2% to 3.4%, primarily because there were concerns about an imminent recession. Now, it looks like the economy could avoid a recession, thanks to a strong job market and resilient consumer spending.
That’s great news, but it comes with a caveat: rising bond yields. The 10-year yield has rebounded from 3.4% back to 3.9% in a matter of weeks, yet people are still focusing on growth and unprofitable stocks. In fact, 44 of the Russell 3000’s 50 best-performing stocks this year didn’t generate any profits over the past 12 months. That’s strange, considering that higher bond yields should entice investors to focus on profits and cash flows. We don’t expect the Fed to cut rates or the 10-year yield to fall precipitously any time soon, so there’s a bit of cognitive dissonance there.
An improving mood. Investors are in a much better mood this year than in 2022, and that’s completely justified (see above). But in this surge of good news, they may be getting a little too excited. Take a look at the American Association of Individual Investor’s weekly sentiment survey, for instance. Bullish investors now outnumber bearish investors by the widest margin since the bear market began. The optimism is refreshing after a brutal year, but we have to remember that the inflation fight is still far from over, and both rate and recession risks could be present down the road.
So where does this leave you, dear investor?
You may not need to run for the hills, but it could be time to tread carefully. When rates are high, it’s smart to focus on what’s making money now while keeping your guard up with hedges and a defensive lean. Long-term investors may have an argument to take on some risk here, but they need to focus on quality companies, even if those quality companies fall into growth categories.
And if you’re looking for the next trade, remember that there are ways to speculate in a falling market. Multi-directional instruments like options could be suitable for a higher-risk investor looking for an opportunity in a tenuous environment.
We may be in a bull market, but don’t forget that we’re not out of the woods yet, either.
*Data sourced through Bloomberg. Can be made available upon request.