Why is the S&P 500 rallying amidst uncertain times?
While our predicted 2023 stock market rally appears robust at first glance, the reality reveals a different story. Initially, pessimists expected the aggressive series of interest rate hikes in 2022 to have significant consequences. Consensus the U.S. faces a recession, led many to predict a decline in stock values. However, contrary to these expectations, the U.S. economy has continued to grow, and the S&P 500 Index, which influences global investor sentiment, has risen by over 15.3 per cent this year.
Believe it or not, with just 10 days remaining until 30 June, the S&P500’s performance already stands as one of the index’s strongest half-year performances in two decades.
Nonetheless, this rally is heavily reliant on a small group of tech-heavy companies. If we strip away these few companies’ contributions, the overall index shows little progress.
And what is particularly interesting is that the same narrow band of securities are responsible for gains in some corners of the bond market.
The world’s riskiest sovereign bonds are currently experiencing a favourable moment as Wall Street investors pursue high yields from countries displaying early signs of market-friendly economic shifts. So far this month, junk-rated government dollar bonds from countries like El Salvador, Nigeria, and Turkey have been outperforming. I wonder whether, amid orthodox monetary policy settings, high-yield markets can continue attracting capital, especially as major central banks reiterate their commitment to combating inflation.
Elsewhere, a rally in junk bonds, specifically distressed high-yield or “junk bonds,” is also being led by a small handful of debt issuers. This situation is similar to the phenomenon referred to a moment ago in the stock market, where a few companies have been driving significant gains. In the case of junk bonds, the gains are being fuelled by the performance of bonds issued by Altice USA Inc. (ATUS), Carvana Co. (CVNA), Community Health Systems Inc., (CYH), Lumen Technologies Inc. (LUMN), and Rackspace Technology (RXT).
According to the Bank of America, the gains in the bond prices of these five issuers accounted for about two-thirds of the recent rally observed in the CCC-rated category of distressed debt.
The rally in junk bonds comes despite hints from the Federal Reserve about additional interest rate hikes. The Fed’s aggressive rate hikes to date have led to increased corporate defaults, particularly among riskier companies that accumulated cheap floating-rate debt during the pandemic.
Like the stock market, investors in both the junk bond market and sovereign bond market, are seemingly willing to embrace higher risk in pursuit of higher returns. And this seems counterintuitive given the prospect of higher rates and the non-zero probability of a recession. To say nothing of the potential risks associated with the creditworthiness of the higher-risk issuers.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
