The first trading day of May was largely uneventful, with low volumes amid a holiday in many markets. (ddp)

The VIX index of implied stock volatility fell to its lowest level since late 2021, while the MOVE index of Treasury volatility dropped to levels last seen before Silicon Valley Bank’s collapse. The first trading day of May was equally uneventful, with low volumes amid a holiday in many markets.

However, both the Federal Reserve and the European Central Bank have a rate decision coming up this week, while markets will get a pulse check on the health of the US economy through multiple data points and corporate earnings. We maintain our selective approach to equities as we believe current markets may show complacency amid a number of risks on the horizon.

The US economy is slowing. While the ISM Manufacturing PMI in April (47.1) rose from March’s reading (46.3) and came in above consensus forecasts, it remained in contraction territory (below 50) for a sixth consecutive month. This is in line with our view that the manufacturing sector is in a mild recession. GDP growth for the first quarter also slowed more than expected amid tepid business investment and a pullback in inventories. At an annualized pace of 1.1%, first-quarter GDP growth slowed from 2.6%in 4Q22.

The impact of banking turmoil continues. US regulators on Monday formally seized First Republic Bank and said its assets will be sold to JPMorgan. While the deal allows customers to access funds, deposits, and usual banking services, this marks the third major US bank failure since mid-March. We continue to believe that banks are likely to tighten lending further, and more restrictive credit standards would see corporate profit growth come under pressure.

Debt ceiling talks may add to volatility. Treasury Secretary Janet Yellen said in a letter to Congress that the agency will be unlikely to meet all US government payment obligations potentially as early as 1 June, after several months of partisan tensions over raising the debt limit from its current USD 31.4tr borrowing cap. President Joe Biden is set to host talks with congressional leaders from both parties next week, but progress on resolving the standoff is unlikely to be apparent until later, in our view. The debt ceiling may stoke more cross-asset volatility in the near term, adding to a challenging outlook for US equities.

So, we recommend diversifying beyond the US in our global equity strategy, favoring emerging markets and more defensive sectors such as consumer staples and utilities. Overall, we prefer bonds to equities. We see attractive opportunities in high-quality fixed income due to decent yields and the scope for capital gains amid slowing growth.

Main contributors - Mark Haefele, Daisy Tseng, Christopher Swann, Jon Gordon

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

Original report - Market risks warrant a selective stance on stocks, 2 May 2023.