Following a shortened trading week in which equities declined, commodity prices shot higher, and US 10-year Treasury yields hit a new three-year high, US equity futures are pointing to further selling pressure this morning.
Recession fears led the US 2-year/10-year yield curve to invert earlier this month for the first time since 2019. However, this inversion did not last long. The short end of the curve or 2-year Treasury yields hovered near 2.5% indicating that the Fed will raise rates by 200 to 225 basis points by year-end; meanwhile, 10-year yields are a few basis points away from 3%.
No one has an answer as to when and how a recession will hit. But the probability of one occurring is on the rise. Inflation in the world’s largest economy is running at a four-decade high, the Fed is scrambling to tighten policy and likely to start raising rates in 50 basis points increments, China’s zero-Covid policy is creating further supply chain shocks, and of course there is a war in Ukraine that is showing no signs of ending soon.
While Fed officials remain confident that tightening policy will not crash the economy, many believe the pace of tightening and balance sheet runoff are the ingredients for a hard landing. We will get to know who’s right over next 12 to 18 months.
What we know now is that the rise in US Treasury yields is harming risk and we can see it in most asset classes including tech stocks, consumer cyclicals, and even digital currencies and NFTs. Such tough times may bring long term opportunities as valuations come down to earth, however we’re still far away from cheap valuations when it comes to growth stocks.
Sector that tends to outperform the market in such times are the defensive ones. Utilities, consumer staples, and healthcare are the three main defensive sectors and that why they all posted gains this month. So, if an investor is in the recession camp, these are the sectors that they are likely to be overweight in.
The earnings season kicks into a higher gear this week with results from American Express, Bank of America, Bank of New York Mellon, IBM, Johnson & Johnson, Netflix, and Tesla. Investors need to see strong beats and positive guidance to keep taking risk as US 10-year yields approach 3%.
