The latest rally is a reminder that market rebounds can be swift and underlines the merits of remaining invested. We do expect inflection points in inflation, monetary policy, and economic growth during 2023. (ddp)

Meta gained 23% following late Wednesday’s announcement of stricter cost controls this year, a better-than-expected sales forecast, and a USD 40bn share buyback program. This helped the Nasdaq finish 3.3% higher. The S&P 500 rose 1.5%, led by the communications services sector—which contains Meta—along with the consumer discretionary and IT sectors.

However, other big tech news, released after the close on Thursday, was not as rosy. Apple reported a steeper sales decline, Amazon projected lackluster revenue in the current quarter, and Alphabet's results narrowly missed analyst expectations. S&P 500 futures for Friday's session were down 0.8% at the time of writing, while Nasdaq futures were down 1.6%.

The 2-year and 10-year US Treasury yields fell 2 and 3 basis points, respectively, on Thursday. In Europe, German Bund yields dropped sharply. The 10-year yield declined 20bps after the European Central Bank struck a less hawkish tone than expected. Peripheral bond spreads narrowed, the Stoxx Europe 600 gained 1.4%, and the euro fell 0.7% against the US dollar.

The ECB increased the deposit rate by 50bps to a 15-year-high, in line with our and market expectations. Moreover, policymakers said they intend to deliver a further increase of 50bps in March, which would take the deposit rate to 3%. The central bank also confirmed the pace of bond sales from its balance sheet at EUR 15bn per month from March to June.

Earlier, the Bank of England also raised rates by half a percentage point to 4%, lifting borrowing costs to their highest level since 2008. But the central bank dropped the commitment to “forcefully” increase rates in the future, suggesting that the appetite for further hikes is waning.

What do we expect?

On US policy rates, markets are interpreting Wednesday’s FOMC meeting in a dovish light. Federal Reserve Chair Jerome Powell chose not to push back explicitly against easier financial conditions in his press conference and referred to a “couple more” rate hikes, giving the impression that the cycle is drawing closer to the end. But the Fed’s comments also contained plenty of more hawkish elements. The Fed remains concerned about the risk of doing too little. As Powell stated, the Fed's job of fighting inflation was not fully done and that it would be very premature to declare victory. We continue to believe that markets have moved too far and too fast in pricing a dovish pivot in Fed policy.

Similarly, while the overall message from the ECB continues to be hawkish—President Christine Lagarde suggested there is “still ground to cover” and the bank is focused on “staying the course”—the language was not as hawkish as it could have been. The nod toward the ECB becoming more “data-dependent,” and the acknowledgement that the risks to the outlook are dual-sided, have left the door open to a more flexible approach going forward. The ECB intends to deliver a further 50bps hike in March, and we also expect a 25bps increase in May. The risks in terms of the pace of hikes remain to the upside, in our view.

The BoE signaled that an end to the tightening cycle appeared to be in sight. With the economy slowing, inflation falling, and unemployment rising, we still expect the BoE to unwind some of the policy tightening undertaken over the past 10 meetings. In our view, the central bank is likely to be cutting rates as soon as the fourth quarter.

The latest rally is a reminder that market rebounds can be swift and underlines the merits of remaining invested. We do expect inflection points in inflation, monetary policy, and economic growth during 2023.

However, in our view, the speed of the recent rally has partly been driven by technical rather than fundamental factors. Many investors were lightly positioned in risk assets at the start of 2023, having scaled back in response to worries over a global recession and a potential energy crisis in Europe. That has started to change. Systematic strategies are adding risk, while hedge funds are not just covering short positions, but also starting to add new longs. This change in positioning has supported equities, but over time we expect the fundamentals to reassert themselves. In the near term, growth is slowing, inflation is high, and rates are still rising.

How do we invest?

We continue to see near-term headwinds for markets despite the latest rebound. But we recognize that some parts of the market will reach inflection points before others, meaning dispersion between different geographical markets and sectors is likely to be elevated. We therefore think selectivity will be rewarded, and our positioning reflects that.

We like strategies that provide exposure to equity market upside while adding downside protection. We incorporate a combination of defensive (consumer staples and healthcare), value, and income opportunities that should outperform in a high-inflation, slowing-growth environment, alongside select cyclicals that should perform well as and when markets start to anticipate the inflections.

In equities, we maintain a least preferred stance on US equities and the technology sector. Instead, we prefer emerging markets including China, as well as German equities, which we expect to be among the main early beneficiaries of China’s reopening and an inflection point in global growth in 2023.

In fixed income, we maintain a preference for high grade and investment grade bonds, given continued near-term threats to global growth along with attractive all-in yields. We also like emerging market bonds, which we expect to benefit from China's reopening and the recent downshift in the pace of US rate hikes.

Main contributors - Mark Haefele, Vincent Heaney, Christopher Swann, Christopher Swann

Content is a product of the Chief Investment Office (CIO).

Original report - Tech leads US stocks higher, 3 February 2023.