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Is Risk-Off Coming?

Is risk-off coming? If you’re willing to look beyond just the S&P 500, the Nasdaq 100 and bitcoin, the signs are there. Since the middle of February, those two indices are both up about 3.5%. During the same time, however, long-term Treasuries are up more than 2%. Utilities are up nearly 5%. Gold is up more than 6%. It’s not often that you see these three traditionally defensive asset classes moving in unison to this degree and, when they do, it’s usually a precursor to a shift in the markets. Of course, this doesn’t guarantee that a major risk-off pivot will happen just as there’s no guarantee you’re going to crash your car when driving in a thunderstorm. But the setup is definitely there. I’ve been saying for several weeks that March was when conditions were setting up to change. It started with a slow shift in the signals, which have been moving towards more neutral positioning for a little while now. The rally over the past several days, especially in utilities and gold, could be an indication that this shift is beginning to accelerate.

There are always catalysts that could either end or extend the current trend. This week, it’s the non-farm payroll report coming on Friday where expectations are for another gain of around 200,000 jobs. Couple that with low initial jobless claims and a JOLTS report showing little slack and you’ve got a labor market that’s still looking pretty tight. Even if we get an unexpected slowing in job growth this week, I suspect the market will want to see that trend continue for at least a couple more months before really reacting negatively to it. That being said, this number could impact interest rates more quickly and expectations of where the Fed might want to take monetary policy later this year. Investors are still hoping for more rate cuts coming in 2024, but the data - jobs, inflation, growth - are moving in a hawkish direction.

Investors have shaken off the recent rebound in inflation, but that may not be the wisest move. In case anyone has forgotten what happened in 2022, the simultaneous correction in both stocks and bonds happened because of rising inflation, which triggered an aggressive Fed rate hiking cycle. While the increase we’ve seen so far in 2024 doesn’t qualify as aggressive, it is enough to start taking future rate cuts off the table. We’ve already seen the markets go from pricing in six rate cuts this year down to three. We’ve already seen an anticipated March start date for cuts get pushed back to June and perhaps even beyond that depending on where the data trends. Now, we just got Fed member Raphael Bostic saying that the Fed may only cut twice this year with a pause in between them. The markets are getting progressively more hawkish here, the data is supporting it and I think that’s why we’re seeing utilities and gold starting to react here.

In total, I’m feeling strongly that this market rally is entering its final innings. We’ve seen these types of rallies in defensive assets over the past year or so, but only briefly. This time around, however, the cautious tone looks like it’s being confirmed by all the data points that have mattered to investors over the past several quarters. In particular, inflation and the Fed. Let’s not forget that the magnificent 7 trade is also starting to fade. Don’t be surprised if sentiment turns slowly and then suddenly.