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Thought of the day

US equities have taken a breather in recent days as markets wait for more cues from upcoming economic data. The S&P 500 is down 0.2% so far this week after hitting an all-time high on Friday for the 13th time this year. With help from solid spending and broadening demand in artificial intelligence (AI), the benchmark has made gains in 15 of the last 17 weeks.

But investor sentiment can be fragile, especially as markets sit at record high levels when the outlook for the US economy remains uncertain. Data published on Tuesday showed that US consumer confidence in February fell for the first time in four months, with concerns over the economy and the presidential election overshadowing their outlook.

Inflation remains at the forefront of consumers’ minds. While the average inflation rate expectation over the next 12 months continues to ease and now stands at the lowest level since 2020, overall inflation remained the main preoccupation of US consumers, according to the statement published alongside the Conference Board’s reading. The stronger-than-expected consumer price index (CPI) for January has caused markets to scale back the expected pace and scale of the Federal Reserve’s rate cuts this year, and this week’s release of personal consumption expenditure (PCE) offers another glimpse of the health of the US economy. While we continue to expect inflation to recede over the course of 2024, another strong reading in the Fed’s preferred gauge of inflation is likely to trigger further volatility.

The US presidential race is adding to anxiety. The Conference Board statement points out that US consumers are now a bit less concerned about food and gas prices, but there are growing uncertainties over the US political environment with the presidential election later this year. With former US president Donald Trump staying in the lead in Republican primaries, media coverage on the campaigns and potential policies could also affect market sentiment in the lead up to November.

All-time highs often generate investor concerns. Our analysis has shown that worries that markets have peaked after all-time highs are not typically warranted. Over the past 60 years, average S&P 500 returns in the year following a record high were no different from the one-year returns from other periods. In fact, average returns for the three-year periods after a new all-time high were slightly higher than entering the market at other points. However, further exposure after such a large rally can also be psychologically challenging for investors, and market reaction to negative headlines may be larger than that to positive catalysts.

So, against this backdrop, we think one important action investors can take is to hedge market risks. In fact, a mix of low equity market volatility and high bond yields makes this an attractive time to consider strategies that allow investors to capture market upside while protecting against downside. We see opportunities in capital preservation strategies, oil and energy stocks, gold, and hedge funds.