A higher-for-longer interest rate environment could mean a “stalemate” for equities after their long upward march in 2023. Stocks continued to rise even as bond yields climbed to multiyear highs and a war broke out in the Middle East. All three major averages are higher by roughly 1% this month and quarter. However, history indicates that’s unlikely to continue, according to Chen Zhao, chief global strategist at Alpine Macro. He expects stocks will trade sideways for some time as investors weigh competing narratives around a robust economy with the pressures of higher bond yields. One notable period of comparison for today’s market environment was in 1994, when a higher-for-longer environment resulted in a market that was essentially flat for the year. The S & P 500 ended 1994 slightly down by 1.5%. Of course, stocks bounced back the following year when the Federal Reserve began to cut rates. In 1995, the broader index surged 34%. “I think that the story here going forward is basically a stalemate,” said Zhao. “You have a growing economy that’s resilient, no question about it. … But at the same time, you have rising borrowing costs, rising discount factors that actually tamp down asset values.” “So you end up with the same kind of phenomenon as you dealt with in 1994. Same thing. Stock prices basically didn’t go anywhere, multiples are coming off. You have a growing economy, but a very, very aggressive Fed,” Zhao said. Still, he expects there will be an end to the sideways trading in the first half of 2024. He anticipates the key to unlocking rate cuts from the Fed will be the end of fiscal stimulus and rapidly falling inflation, which will happen faster than the market anticipates. “You’re not going to have a major bear market but you’re not going to have a major advance. It’s a stalemate,” he said. “On the positive side, you have growing earnings. On the negative side, you have a higher discount factor. So you basically create a standoff or stalemate.” Until then, however, the strategist holds a cautious view on both stocks and bonds. He advises investors to stick with cash or venture into international equities. Others expect the rapid rise in interest rates could mean a hard landing for the economy. Sri-Kumar Global Strategies president Komal Sri-Kumar noted equities hit a low after rapid rate increases in the 1980s resulted in the 1981-82 recession. He does not expect equities have currently priced in a recession and advised traders to reduce their exposure. “I am waiting for something to break,” Sri-Kumar said. “I think something will break because of the speed with which interest rates have increased, and at the same time, the balance sheet of the Federal Reserve has been constricted, both happening at the same time.” Elsewhere, JPMorgan’s top strategist Marko Kolanovic also urged caution, advising traders to buy gold and remain underweight stocks. “History suggests this relationship is becoming increasingly unsustainable, posing risk to the equity multiple. The current level of real rate (~2%) implies S & P 500 multiple is overvalued by ~2.7x (or ~3.9x if post-Covid stimulus and TMT bubble episodes are excluded),” he said.
