Deep Dive video: Positioning in gold in the second half (6:47)

CIO’s Wayne Gordon explains why prices can snap higher in the coming months.

Thought of the day

US manufacturing activity data released on Monday painted a gloomy picture of the sector. The flash ISM survey reading for June came in at 46, below the consensus expectation for 47. The index has now been below the 50 level associated with contraction since November.

The data also underlined the challenge for the Federal Reserve, with falling prices in the manufacturing sector while parts of the services sector still look overheated. The prices paid component of the manufacturing sector dropped to 41.8 in June, versus expectations for 44, pointing to accelerating disinflation. While suggesting some easing of services price pressures, inflation data on Friday showed a year-over-year rate of 4.5% in services excluding energy and housing costs. Fed Chair Jerome Powell stressed again that policymakers had still not “seen much progress in non-housing services.”

Despite the tricky balancing act policymakers face, equity markets continue to price a high probability of an economic soft landing for the US economy. On the eve of the 4 July Independence Day holiday, the S&P 500 has advanced 16.1% so far in 2023 and is 24.6% higher since the low point in October.

Against this backdrop, we favor fixed income along with parts of the equity market that have lagged in the recent rally:

Rising bond yields have provided an opportunity for investors to lock in attractive rates. The yield on the 2-year US Treasury has reached 4.94%, close to the 2023 peak of 5.06% hit prior to the collapse of Silicon Valley Bank in March. The yield on the 5-year US Treasury has climbed from a recent low of just below 3.3% in early May to 4.19% at present. The more defensive, higher-quality segments of fixed income look most appealing to us, given the all-in yields on offer and the potential for capital appreciation as investors shift their focus from inflation risks to growth risks.

Adding exposure to emerging market (EM) bonds can help diversify income sources within a portfolio. A Fed pause, the prospect of lower US rates ahead, and a weaker dollar should support the asset class. And, while China’s recovery has been uneven, we still see good growth dynamics this year in emerging markets. EM central banks also have scope to lower their own policy rates due to moderating inflation. In this context, we see total yields of 8.3% in the EMBIG Diversified sovereign index as representing good value.

Not all parts of the equity market look richly valued, and investors should seek stocks with the potential to play catchup. A handful of mega-cap tech stocks have led the US rally, with the FANG+ index of 10 leading tech firms advancing 75% in 2023, versus 16% for the S&P 500 and 6.3% for an equal-weighted measure of the S&P 500. While the US market is now trading at a near 20% premium to its 15-year average, based on the 12-month forward price-earnings of the MSCI USA index, valuations look less demanding outside the recent leaders. Within US equities, we recommend investors consider switching into equal-weighted indexes where the majority of stocks have catch-up potential. From a style perspective, we favor an allocation to value versus growth.

So, while challenges lie ahead for equities in the remainder of 2023, we see plenty of opportunities to position portfolios to add durable income and increase exposure to neglected parts of the market.