Twin recoveries in Treasuries and US equities may not last

For much of this year, expectations of tighter Fed policy have driven up Treasury yields, weighing on the US stock market’s valuation in the process. That has changed since we published our last Asset Allocation Outlook, as Treasury yields have dropped back amid concerns about the economic outlook. Admittedly, those worries initially contributed to some further weakness on net in equities, given rosy expectations for earnings growth. But it didn’t last long and the US stock market has since recovered sharply amid hopes that the Fed might dial down its plans for tightening amid tentative signs that inflation has peaked. Nonetheless, we doubt that the twin recoveries in US equities and Treasuries, which have led to a slight turnaround in a struggling synthetic 60:40 portfolio this year, will last. For a start, we anticipate that Treasury yields will resume their rise, as the Fed presses ahead with its tightening cycle. We don’t envisage the 10-year yield, for example, peaking until next year shortly before the last rate hike. And although we anticipate that the US economy will avoid a recession, we suspect that slower growth and squeezed margins will cause earnings growth to fall short of consensus expectations and appetite for risk to remain weak. So, we don’t foresee the S&P 500 bottoming out until mid-2023 either.