This summer, between the US public holidays of Memorial Day on 31st May and Labour Day on 6th September, the S&P 500 made a record 28 all-time highs in 69 days of trading, delivering a price return of 7.9%.
The upward grind of stocks in this most unusual of summers ran counter to the “sell in May and go away” adage: on average over the past 50 years, the S&P returned 1.7% between May and September, and 7.3% from September to the following May. But while a summer rally does have precedent, the record number of new highs – against the backdrop of monetary policy uncertainties, Chinese regulatory change, and the ebb and flow of coronavirus statistics – certainly bears scrutiny.
We continue to expect above-trend growth through the end of 2022 and see further upside for equity earnings as economies around the globe reopen fully and pent-up demand materializes. But without doubt, the momentum of growth is diminishing and over the summer we saw economic surprise indices drop from elevated levels.
While moderating growth presents a headwind for stocks, not least by denting sentiment, a supportive backdrop remains in place: ample liquidity, strong household balance sheets and a powerful capex cycle. Crucially, too, not all of the rebound in equity earnings is yet reflected in analysts’ forecasts – providing a basis for further upside.
To be sure, there are some confusing signals across markets – not least from the bond market, which continues to appear detached from fundamental growth and inflation dynamics. But we would argue that this situation could persist for some time, given the ongoing central bank demand for duration, as well as other, less price-sensitive, demand for bonds, such as by pension portfolios de-risking. Even accounting for a tapering of Federal Reserve (Fed) purchases starting later this year, we expect real yields to remain profoundly negative throughout 2022.
In the dog days of summer, we were certainly reminded that risks beyond Covid-19 continue. Regulatory tightening in China, and most recently issues in the property sector, have weighed on the wider emerging market (EM) complex. But even when they did, the US and other developed equity markets remained reasonably poised.
While some would argue a correction might be overdue, even in the event of a drawdown, we would expect buyers to emerge quickly – noting, as we do, that the underlying combination of growth drivers and easy policy probably still outweigh the potential tail-risk issues.
In our multi-asset portfolios, we reflect our economic optimism with continued overweights in equities and credit and continued underweights in duration and cash. Within equities, we maintain a preference for developed markets over emerging markets, with reasonable balance across the US, Europe and Japan – the US providing a quality angle to our exposure and Europe and Japan offering a welcome cyclical tilt. In credit, we favour high yield but at this mid-cycle stage in the economic expansion we note that credit is largely a carry, rather than a capital-growth asset.
On the face of it, very little has changed in our preferred asset allocation since June. However, below the surface we continue to make subtle but important changes within portfolios. Notably, our attitude to duration has shifted.
At the start of the year we expected a rapid rise in yields and could take a pro-growth stance through an underweight in bonds. For a time, stock-bond correlations drifted into positive territory, in turn presenting a challenge to portfolio construction. As the sum of investors’ fears has shifted from inflation to growth, negative stock-bond correlation has reasserted itself and, despite low prevailing yields, bonds once again play a valuable role in portfolios, offsetting pro-risk positions taken in stocks.
While we continue to expect yields to rise from here, we expect both the scale and pace of yield increases to be modest. For investors with a significant pro-risk stance in equities, the portfolio benefits of holding duration may now outweigh the mildly negative outlook that we have on bonds in isolation.
In sum, we maintain a pro-risk tilt mainly through stocks. While we see the momentum of equity returns moderating, we do not expect a change in the direction over the coming months. The greatest risk to our portfolio stance today is a disappointment on growth – not an overshoot in inflation. But at the same time, we note that policymakers around the globe remain committed to supporting nominal growth and this, in our view, provides a supportive backdrop for risk assets.
John Bilton is global head of multi-asset strategy at JP Morgan Asset Management. The views expressed above are his own and should not be taken as investment advice.