Powell and Yellen Tag Team the Yield Curve as the Market Broadens
The market has broadened with many sectors performing just as well as Technology
Jerome Powell and Janet Yellen are working together to combat the inverted yield curve, this is making for a better environment to cut interest rates. While this is happening we are seeing a broadening out of the market with many sectors experiencing Technology-like performance, with less downside risk.
Topics
Market Valuations and Broadening Across Sectors
Powell and Yellen Tag Champions
Market Valuations and Sectors that are performing like Technology
Market valuations remain elevated, with Technology having the highest valuations. The big names in the index still dominate the S&P 500 performance and these names have pushed valuations past 2 standard deviations away from the mean. The chart below is the Shiller PE Ratio up until March 1st, 2024, over the past 20 years.
If you remember the statistics section from math class, or even if you don’t, 95% of all events occur within 2 standard deviations of the mean. This would mean you are outside of this area only 5% of the time. We are currently at valuations that very rarely occur and are not likely to be sustainable. If these valuations were to contract the areas with the highest valuations would be hit the hardest.
We have started to see a change this year as many investors are mitigating this risk by rotating out of Technology and buying the other sectors of the market. This is an apparent risk/reward bet, where investors can take less downside risk and are being rewarded with the same upside returns.
Over the past month, we have seen outperformance in Energy and Materials while seeing similar performance in Utilities, Industrials, and Financials. These areas have shown a better risk/reward scenario given the valuations in the Technology sector over the past month.
Powell and Yellen Tag Team Champions
Jerome Powell remained firm in the statement released yesterday that they are waiting to see more progress before cutting rates. While the market predictions have been all over the place, the Federal Reserve has remained constant, and they are going to cut 75 bps (0.75%) this year. He reiterated this yesterday, which leaves 9 more months to announce these cuts, which are likely to happen 3 times with 25 bps each time. With the first cut predicted to be in June. The Bank of Canada is also expected to cut for the first time in June. This would line up everything from a currency perspective, outside of that with increasing unemployment and lower inflation Canada is justified to cut earlier.
Janet Yellen used to be the Chairwoman of the Federal Reserve before becoming the US Secretary of the Treasury and now we are starting to see her role become slightly more impactful. While the Federal Reserve Chairman (Jerome Powell) sets the interest rates, don’t forget how the Secretary has a few tricks up her sleeve. What we have seen over the past 9 months shouldn’t be ignored as the Treasury is helping to manipulate the yield curve.
The US Government recently has made a shift into the type of debt that it issues. In the past, most of the debt that they issued has been short and medium-term debt (2-10 years), but in recent quarters, Janet Yellen has changed that mix and issued more long-term debt (20-30 years). By changing this mix, she is creating a greater supply of long-term debt and a smaller supply of short-term debt. This creates greater demand for the short-term debt and less demand for the long-term debt. The result should lower interest rates on short-term debt and increase rates on long-term debt. This could help bring the yield curve back to normal, along with the cutting of rates. This has been something the Federal Reserve is having trouble doing, while they control the short end, the market controls the long end. Even with the great increase in interest rates, very few believed the Federal Reserve could keep rates high for long. With Yellen’s help, the long rates have been more resilient and could see less of a decline once Powell starts cutting rates.
Summary
The market is broadening, and this is becoming a healthier market than it has in the past. While Technology continues to perform some areas provide better downside protection for less risk. It will be interesting to see how long Technology can hang without the outperformance it has had in the past. The inflation/interest rate story is still unraveling at a very slow pace, the Federal Reserve remains steadfast and is in no rush to do anything until they see the whole story. Since December they have said 75 bps of cuts in 2024 and have not wavered. They will need to cut PRIOR to a drop in economic numbers or else they have waited too long; therefore the June cut makes a lot of sense right now.
Justin, Konrad, and Merriel
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