Invesco: Rate cuts bring limited upside to US stocks, overweight fixed income allocation

According to the Wise Finance APP, Zhao Yaoting, the global market strategist for J.P. Morgan in the Asia-Pacific region (excluding Japan), stated that Federal Reserve Chairman Powell delivered an economic policy speech at the Jackson Hole Global Central Bank Annual Meeting, indicating that "the time for policy adjustment has come." The recent rise in the U.S. stock market may reflect investors' belief that interest rate cuts will drive stock prices higher. He mentioned that it is uncertain whether the Fed's first rate cut in September will lead to a comprehensive rebound in the stock market, and it may be more reasonable to focus on fixed income relative to stocks.

The limited upside brought by rate cuts to the U.S. stock market

Looking back to when the Fed started raising rates in 2022, U.S. stocks fell as yields rose. Conversely, will the market rise when the Fed starts cutting rates?

The answer may be no, because the starting point for relative valuations is different. In 2022, based on the relative risk-adjusted benchmark, U.S. stocks were more expensive than U.S. bonds.

Zhao Yaoting stated that with the recent rise in stocks, the current situation is very different. U.S. stock valuations seem to have reached fair value, and there is not much room for upside from rate cuts. Therefore, he believes that the Fed needs to cut rates faster and more aggressively to bring bond yields to unfavorable levels, thereby significantly benefiting stocks from rate cuts.

The biggest risk the market faces in the next 12 months is whether the U.S. economy will experience a "hard landing."

He mentioned that growth remains below trend, and the labor market reflects deepening economic fissures. Although the market has not been significantly affected by these developments, negative economic factors are intensifying. The U.S. Department of Labor recently revised down non-farm payroll data, marking the second-largest negative revision on record. Leading indicators show that the U.S. economy continues to slow down. He believes that investors should increase defensive deployments, and it may be more reasonable to focus on fixed income relative to stocks.

Focus on fixed income

Based on valuations and risk-adjusted benchmarks, U.S. stock valuations seem too high, so increasing the duration and credit allocation of the portfolio is more reasonable, especially as the Fed begins a rate-cutting cycle.

In addition, the U.S. presidential election is approaching. Looking back at the past 7 election cycles, regardless of the election results, the one-year returns of various credit sectors in the U.S. have been strong after the election.

As the current polling results remain close, it is still difficult to predict the outcome. The future may usher in a "Trump 2.0" era, which could bring economic and geopolitical uncertainties, thereby weakening risk appetite.

Zhao Yaoting stated that the macro conditions of the U.S. fixed income market are mature: the Fed is about to cut rates, U.S. recession risks are increasing, and the U.S. election brings uncertainties. Therefore, based on strong arguments, it supports deploying bonds of different durations As the Federal Reserve is about to cut interest rates, short-term Treasury bond yields may decline, while long-term yields may also fall due to recession concerns.

Investors may also allocate to investment-grade and high-yield bonds to take advantage of the currently attractive yield environment, while strengthening defensive positioning in the face of uncertain U.S. macroeconomic and political outlook.

Investment Risks

The investment value and any income will fluctuate (partly as a result of exchange rate fluctuations), and investors may not be able to recoup the full investment amount