Post FOMC: Stay engaged in risk assets

Our analysis of the US global cyclicals over non-cyclicals ratio vs the UST 10-year yield suggests that the bond market has overpriced US recession risk.
Chief Investment Office01 Nov 2019
Photo credit: AFP Photo

What happened?

Federal Reserve’s “hawkish” rate cut and positive US earnings season. In October’s Federal Open Market Committee (FOMC) meeting, the Federal Reserve cut the Fed funds rate by 25 bps, as expected. This brings total cumulative rates cut to 75 bps in the current mini-easing cycle. Fed Chair Jerome Powell struck a hawkish tone in his latest statement, signalling the end of policy easing, for now.

On the corporate front, the US’s third quarter earnings season continues to progress steadily with c.80% of the companies reporting positive earnings surprises (vs 76% in 2Q19), led by Technology. Despite frequent talks that the positive US earnings is due to shares buyback, data suggest otherwise. To nullify the “impact” of buybacks, we look at the proportion of companies reporting topline revenue growth instead – it is positive at c.71% in 3Q (vs 66% in 2Q19).

What does this mean?

Inflection Point: Steepening yield curve and positive earnings are constructive for risk assets. Back in August, the inversion of US Treasury (UST) 2s/10s yield curve triggered concerns over a broad-based recession. In CIO Perspectives: Yield curve inversion – Much ado about nothing?, we argued that the yield curve has lost its predictive power as the long-end has been artificially suppressed by quantitative easing measures and weak bond yields outside the US.

More importantly, we believe that the bonds market has overpriced US recession risks as the US-China trade war lingers. This is evident in Figure 1, which shows US global cyclicals vs non-cyclicals and the UST 10-year yield. The UST 10-year yield has currently overshot the former (on the downside) and a similar occurrence in mid-2012 saw the 10-year yield rebounding sharply after. 

In any case, the yield curve has since widened from -0.79 bps back in end-August to the current level of 15.23 bps. A steepening yield curve points to rising confidence in the domestic US economy. And despite the recent softness in US manufacturing (partly as a result of trade concerns), we expect domestic consumption to stay resilient given the robust job market and stable consumer confidence.

What should you do?

Maintain Overweight stance in US equities. We have adopted an Overweight stance on US equities since the start of 2018 and our view remains unchanged. The sectors we favour are Technology, Communication Services, Health Care, Real Estate, Energy, and Consumer Staples.

Figure 1: The bond market has overpriced US recession risks

Source: Bloomberg, DBS

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