Written by:  Mutsumi Kagawa (Chief Global Strategist, Economic Research Institute of Rakuten Securities)

(03/03/2023)

1. Inflation expectations in the US market are rising.

In the US market, while the outlook of an interest rate cut within the year has receded, stocks are making adjustment due to growing concerns about the impact of prolonged monetary tightening on the economy. Major macroeconomic indexes and inflation indexes reported since February exceeded market forecasts, prompting widespread speculation that inflation will remain at a high level. The long-term interest rate (10-year bond yield) in the bond market reached a milestone of 4% (March 1). Chart 1 shows changes in the BEI (Break Even Inflation Rate) estimated in the US bond market over the past year. The inflation expectations rate is the fixed-rate bond yield minus the inflation-indexed bond yield and is regarded as the inflation rate expected by the market. According to this, 2-year inflation expectation rose sharply since February, reflecting that current inflation outlook is getting worse (assuming the inflation is accelerating). Bond interest rates rose in response to these movements. The short-term bond interest rate (2-year bond yield), which is particularly sensitive to policy interest rates, has risen close to 5%. In fact, the year-on-year rate of increase in January of the PCE (Personal Consumption Expenditure) price index which is closely monitored by the FRB announced on February 24, was +5.4%, up from December (+5.3%). Inflation and interest rate trends remain a cautionary factor for stocks.

2. Check the year-to-date changes and performance outlook by sector

While year-to-date change of the S&P 500 index has shrunk to +2.9%, when looking at the changes in the “11 major industry stock indexes” in Chart 2, there are differences between good and bad (March 1). The 3 best-performing sectors for year-to-date changes are “consumer goods & services”, “IT (information technology)” and “communication services”. Looking at the forecasted earning changes in 2023 and 2024 for consumer goods and services, each year is expected to continue increasing by about 20%. Although IT (information technology) and communication services are forecasted to see a slumping performance in 2023, they are expected to recover by about 15% in 2024. On the other hand, the “energy” sector had increased earnings in 2021 and 2022, is expected to inevitably decline in 2023 and 2024 due to the recent deterioration in the crude oil market. This can be a reference for diversified investment by sector (industry).

Looking at the performance based on the S&P500 Index shown at the bottom of Chart 2, it is forecasted that earnings will decline in 2023. However, it is expected to return to double-digit growth in 2024.  Although it depends on changes in future inflation, interest rates and business sentiment, I believe that the stock market as a whole is likely to recover in the second half of 2023 and turn to  positive growth in 2024.  Looking at the S&P 100 index (comprised of 100 major market capitalization companies), the three best year-to-date growth are Tesla (+64.6% year-to-date), Nvidia (+55.3%) and Meta Platform. (+44.1% year-on-year). It shows the trend that some tech stocks are being sought after this year. When the market falls in the short term, I am also paying attention to the possibility of buying a bargain in these stocks on a recovery trend.

3. Is the stock market waiting for bond rates to stabilize?

It is undeniable that the stock market is being weighed down by the rise in bond yields  due to the above-mentioned rise in inflation expectations. As explained in a previous article, stock prices are close to the discounted present value of forecasted future corporate earnings (cash flows). We should take note that a rise in bond yields, which has a large impact on discount rates, will continue to put downward pressure on stock prices. Chart 3 shows changes in the S&P 500 index, its upper resistance and lower support lines, and bond yields (2-year bond yield and 10-year bond yield). Due to bond yields, which had been stable until January, increased in February (bond prices fell), the S&P 500 Index has fallen below the 4000 level , which was considered a milestone, and is approaching the milestone support line and the 200-day moving average (3940 points). If bond yields rise further and the S&P500 Index falls below the 200-day moving average line, there may be risk that the downside will drop to about 3800 points due to further  selling.

However, if the futures market has factored in the forecast of the terminal rate of the policy interest rate (the target point of the policy interest rate), which has risen in the futures market, and if there is a consensus that there is a delay after the rate cut, the rises in bond yields  may slow down and stocks may temporarily stop falling. In any event, the market is likely to be in a tug-of-war between bond yields and the economic outlook (earnings outlook) due to rising inflation expectations in the near term. However, if we expect an economic recovery and an improved earnings outlook for 2024, it seems that there is still “a good chance for long-term investment”. If stock prices are to fall in the immediate future, I believe buying on decline and bargain hunting will be appropriate.