What’s New

They say that March comes in like a lion and out like a lamb, and while the brief drawdown we saw in equity markets to start the month was hardly ferocious, investors were surely comforted by equities continuing to drift higher through month-end.

Yet under the surface, things appear to be shifting. As bond yields continued to grind higher on the back of a still-resilient economy and upside risks to inflation, equity markets have seen a rotation in leadership. Year-to-date, US equities have been led by momentum, quality, and growth.

From a sector perspective, Communication Services and Information Technology had been the clear leaders coming into March. March saw a strong surge in the performance of Energy and Materials – sectors more traditionally associated with higher yields and stronger economic growth. Rather than momentum or growth, value was the strongest performing sector of the month. The almighty Information Technology sector has started to show cracks, with Apple (AAPL) continuing to move lower and non-semiconductor industries amongst the worst performing of the month.

What accounts for the shifting dynamics in equity market performance? In our view, the market is continuing to price in the much-discussed soft landing scenario. Concentration in equity market performance was driven largely by a belief in the ability of a small number of companies to deliver strong and visible earnings growth in an uncertain environment.

Thus, the increased belief in the ability of the Fed to engineer a benign outcome is likely behind the broadening out of equity market performance into more economically sensitive areas.

This is perhaps no more apparent than in the leadership we saw in March from the Russell 2000, which delivered a total return of 3.4% versus the S&P 500 at 3.1% and the Nasdaq at 1.8%.

Our Perspective

While we acknowledge the resilience we have seen in the US economy and the progress we have seen in bringing inflation back toward the Fed’s target, we continue to see and monitor risks. Rising rates may yet again begin to pressure borrowers, especially small- and medium-sized businesses. Inflation is no longer falling at the pace it was, and core service inflation (excluding shelter) has stalled out at a level well above pre-COVID levels.

Meanwhile, valuations are far from attractive at a broad level, and it leaves us wondering what many market participants are paying for. Nevertheless, we have continued to find opportunities in the market, with risk management at center stage. Overall, as growth continues to slow, we remain defensively positioned in our core portfolios.

Although the market is pricing in a soft landing scenario, we believe that one is unlikely as we progress through the economic cycle as historical evidence suggests that the Fed has never brought inflation down from the levels we’ve seen without causing significant economic hardship. With three cuts planned for the year, we’re closely monitoring for signs of weakness and what it all can mean for the start of a rate-cutting cycle.

Negative Rates No More

After embarking on a path of ultra-loose monetary policy to help stimulate the economy, Japan’s grand experiment is finally coming to an end as the Bank of Japan voted to end their yield curve control program and raise borrowing costs for the first time since 2007.

With this also comes the end of negative interest rates as Sweden, Denmark, the European Central Bank, Switzerland, and Japan (the final holdout) are all once again in positive territory. Read our analysis here: Negative Rates No More

Our View

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Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.