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US Perspectives: For US equities Fed liquidity provides stability
Apr 3, 2023
- US equity markets have struggled this year, especially in the past few weeks, as the stability of the US financial system has been called into question. Despite fears of recession, stubbornly high inflation, and one of the most aggressive Fed tightening cycles we have ever seen, US markets have outperformed the MSCI world index and emerging markets through mid-March
- The government has provided several forms of support by delivering liquidity through the Fed’s discount window, one-year loans through the Bank Term Funding Program (BTFP), and other forms of liquidity. As a result, we believe this is not a systemic issue but an issue of liquidity that has affected smaller US banks
- Prospects for economic growth remain weak, and the outlook for earnings has declined meaningfully in 2023 given the lagged effects of higher interest rates due to the Fed’s tightening cycle. In the first half of the year, analysts estimate for S&P 500 earnings look for a decline by -5.0 per cent. But in the second half of the year, estimates are much more positive and forecast earnings are expected to rise by +6.3 per cent. For the calendar year 2023, bottom-up earnings’ estimates have declined meaningfully from the beginning of the year and as of mid-March are +1.9 per cent
- US equity investors can take solace in the fact that the peak in rates seems close. Based on the six prior tightening cycles, when the Fed pauses monetary policy tightening, it provides a good base for future US equity returns. In fact, the average return for the S&P in the past six cycles has been +19 per cent in the 12 months after the Fed pauses. There is also good news from a bottom-up perspective. Ac-cording to FactSet, industry analysts predict the S&P 500 will see a price increase of 17 per cent over the next 12 months
- We continue to focus on quality companies with strong balance sheets, cash-generating capabilities, and low levels of net debt. Investors should also pay close attention to sector bets, but this remains a stock-pickers’ market, and close attention should be paid to the resilience of underlying business models and the ability to navigate growing pressures ranging from rising interest rates to painfully slow disinflation
- Even though rates remain high and fixed income markets offer an alternative to equities, we are rapidly approaching a point where the potential future equity returns may be sufficiently compelling to cause investors to take note