The Fed’s Greenlight To Resume Risk Taking

Economic growth, employment and inflation were all revised sharply higher for 2021, but interest rates are projected to remain at zero for the next two years.

The S&P 500 reversed early declines of 0.4% to close 0.3% higher at a new record of 3,974. Yields on the US 10-year Treasury remained elevated as Powell didn’t see the urge of taking action or talking down long-term interest rates. Meanwhile, the dollar was the biggest loser of the event, falling against most of its major peers.

Given this kind of environment, the ingredients for higher equity markets remain in place. You have a rapid economic recovery coming out from an induced coma, a Federal Reserve unwilling to pullback from emergency measures and a large amounts of US fiscal stimulus finding their way into equities by retail investors. However, this isn’t a “buy everything” situation. The higher bond yields move from here, the more challenging it becomes for growth stocks to resume their upward trajectory. Highly priced Tech stocks trading at elevated multiples compared to historic averages will likely remain under pressure in the short to medium term, so it makes sense to reduce their weight in portfolios.

On the flip side, value stocks such as those in financials, energy, materials and industrials are the ones to benefit most from this environment. Is it not only fundamental factors, such as easing lockdowns and improving profitability that will lead those sectors to outperform, but also technical ones. The MSCI World Value Index has outperformed the MSCI World Growth Index by more than 10% from the beginning of November last year. Many value stocks are likely to become momentum ones, leading to more systematic trading systems picking them up in their portfolios, hence we expect the outperformance of value stocks to continue in the short to medium term.

While the dollar index fell 0.5% following the FOMC meeting, the ongoing rise in yields and widening spreads should continue to lend support to the greenback. Traders will keep a close eye on the upcoming monetary policy decisions from the Bank of England today and Bank of Japan tomorrow but expect both to echo the dovishness heard from the Federal Reserve.

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