US markets mispriced amid new quadruple rate cut prediction

The latest market analysis from GSFM specialist investment partner, Payden & Rygel, indicates US equity and bond markets are yet to price in an expected economic slowdown and a predicted further four interest rate cuts occurring over the next two quarters.

According to portfolio manager, Eric Souders, said US economic growth is forecast to come in at around one to 1.5 per cent in the next six months, fuelled by ‘growth-negative’ policy and the combined impacts of immigration, tariff and fiscal policies.

Souders said this positions emerging markets well to reap the benefits.

“Forward 12-month price-to-earnings valuations in the US equity market are running above 23 and higher bond spreads are in the bottom decile going back 25 years. We just don’t think that pricing reflects any sort of market recognition of a likely slowdown,” he said.

“The Federal Reserve is in a good position to prioritise growth over inflation in the coming months. The market right now is pricing around two rate cuts by the Fed, but we expect three or four more rate cuts by year end.

“The latest depreciation of the dollar is not very material when you look at some of the moves it has experienced, both positive and negative, over the past 20 or 30 years. We think that has further room to go and it is clear to us that the US is a crowded trade.

“With the US growth policy effectively running below the trend relative to other part of the world, we expect the US dollar to continue to depreciate, which will benefit areas like emerging markets.

“Looking at the direction of capital flows, over the past 10 to 15 years US assets have collectively grown by around US$20 trillion, whereas in emerging markets, we’ve seen outflows for the last three years in a row. So emerging markets is an area that has been quite underinvested by investors compared to the US.”

Souders also said investor confidence in the US has weakened given its mounting debt crisis, encouraging investors to take a more ‘defensive’ stance with their portfolios for the months ahead.

“The US is running a significant deficit, around six to seven percent, and we don’t think it is likely to reduce. Servicing this debt currently equates to around US$2 trillion in funding that needs to be raised each year over the next couple of years,” he said.

“We won’t necessarily see overseas investors selling US assets, rather they will start to buy less of them, or will demand more compensation. This will likely lead to higher yields in the long end of the US yield curve, and could serve to gradually weaken the dollar further.

“Given the backdrop of the US economy, investors should be positioning more defensively today on the credit side. This contrasts with where we were in the third and fourth quarter of last year, where we felt like the market was overpricing in the risk of a slowdown.

“In the current environment, investors should reposition to less credit and more on interest rate exposure in their portfolios, to take advantage of the market not pricing in enough rate cut expectations from the Federal Reserve.

“Interest rate risk is a nice hedge, whether that is a hedge to credit risk or equity risk in portfolios at a time of forecasted economic slowdown and market uncertainty.”