Equities, US economy Is the equity rally sustainable?

Given the risks to the US economic outlook, we see better risk-reward in high-quality bonds than in equities. Within equities, we recommend that investors consider rebalancing toward areas that have lagged this year's rally, like emerging markets, defensives, and value.

Equities have rebounded after a tough 2022.

• The S&P 500 had risen 15% year-to-date as of 16 June.
• The index is trading at around 18.9x forward price-earnings, higher than pre-pandemic levels.
• The VIX index of implied US equity volatility stood at 13.5 on 16 June, well below its long-term average of 20.

But the rally in US stocks has been narrow, and the economic outlook remains uncertain.

• A handful of mega-cap growth stocks have driven the US equity rally this year, benefiting from investors' enthusiasm for potential beneficiaries of advances in artificial intelligence technology.
• Historically, such narrow rallies have been less sustainable.
• The US economy is likely to cool further, and we expect S&P 500 corporate earnings to contract this year.

So, we hold a least preferred view on equities.

• We see better risk-reward in high-quality bonds than in equities.
• Within equities, we recommend that investors consider rebalancing toward areas that have lagged this year's rally, like emerging markets, defensives, and value.
• Our most preferred sectors include consumer staples and industrials. We also like quality-income stocks.

Did you know?

• The capitalization-weighted S&P 500 delivered a total return of 9.6% in the first five months of the year. But its advance has been driven primarily by a handful of mega-cap growth stocks. The equal-weighted S&P 500, which dilutes the impact of mega-cap stocks, returned a negative 0.6%.
• The outsized year-to-date rally in the NYSE FANG+ index (77%), which tracks the top 10 most traded tech companies, underscores how narrow the rally has been this year.
• Historically, narrow leadership has been a hallmark of late-stage bull markets rather than the start of a more prolonged upswing.

Investment view

We hold a least preferred view on global equities. Within the asset class, we recommend diversifying beyond the US and growth stocks given elevated valuations and risks to the US economic outlook. We recommend that investors consider rebalancing toward areas that have lagged this year's rally, including emerging markets, defensives, and value.

Main contributors - Vincent Heaney, Alison Parums

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

Original report - Is the equity rally sustainable?, 20 June 2023.