Invesco: Fed rate cut imminent, taking defensive measures is a wise move

According to the financial news app Zhitong Finance, Zhao Yaoting, the market strategist for J.P. Morgan in Asia Pacific, stated that in this round of interest rate cuts, he leans towards a defensive stance and is overweight fixed income rather than stocks. By observing past interest rate cut cycles, he studies other assets that may perform well during the Federal Reserve's interest rate cut cycle. In terms of stocks, value and defensive assets such as healthcare and consumer staples may perform well, similar to previous interest rate cut cycles. He believes that the bear market for tech stocks may continue until further evidence proves the productivity gains brought by artificial intelligence.

Recent economic data from the United States and China indicates that both economies are heading towards weakness, so a defensive approach should be taken by reducing cyclical assets. Although the weak growth of the world's largest economies may offset the benefits of loose policies, emerging markets and international assets tend to benefit from the Federal Reserve's interest rate cut cycle. In other words, in terms of stocks, Zhao Yaoting believes that similar to previous interest rate cut cycles, value stocks and defensive stocks such as healthcare and consumer staples are likely to perform well.

The tech bear market is likely to continue until there is further clear evidence that artificial intelligence can enhance productivity.

Recent economic data from the United States and China suggests that both economies are moving towards a weaker state, making it reasonable to increase defensiveness and underweight cyclical stocks. Emerging markets and international assets often benefit from the Federal Reserve's interest rate cut cycle, but the weak growth of the global largest economy may negate the benefits of loose policies.

The Federal Reserve's struggle against persistent inflation is coming to an end, but authorities are facing a new challenge of preventing an economic downturn. Recent July JOLTS (Job Openings and Labor Turnover Survey) employment data, August ADP employment figures, and monthly non-farm payrolls from the U.S. Bureau of Labor Statistics were lower than expected, prompting reflection. With the labor market showing signs of weakness after 3 years of strong performance, the U.S. stock market is also affected, with the S&P 500 index falling by over 4% last week, while the yield on the U.S. 10-year Treasury note fell by 19 basis points to 3.72%, marking the lowest level since June 2023.

Recent market volatility reflects investors' concerns about whether the Federal Reserve's first rate cut to prevent an economic downturn is too small and too late. While it is believed that the Federal Reserve will cut the benchmark interest rate next week, deteriorating labor market data may give the Federal Reserve the opportunity to cut rates by more than 25 basis points next week. However, he believes that the likelihood of a rate cut of more than 25 basis points next week is small, as significantly cutting rates before the U.S. election period could lead to market accusations that the Federal Reserve is attempting to influence the election results, and cutting rates too late, as the Federal Reserve should have cut rates earlier.

Zhao Yaoting believes that despite experiencing an aggressive tightening cycle, the United States will be able to avoid an economic downturn.

Reference to the interest rate cut cycle from 1995 to 1996

The last time the Federal Reserve was able to raise interest rates and avoid an economic downturn was during the tightening cycle in 1995. Although history does not usually repeat itself, it often rhymes, so lessons can be learned by studying what happened in the market during the Federal Reserve's interest rate cut in 1996 On July 6, 1995, six months after the Federal Reserve began cutting interest rates, the S&P 500 index rose by 11.32% (chart). Value stocks outperformed growth stocks slightly. The healthcare sector performed the best. International stock markets slightly underperformed the U.S. stock market after the Fed started cutting rates, with bonds recording steady gains.

Overall, the returns over the following six months were more moderate. This may be attributed to the very short duration of the easing cycle, with a small rate cut of only 75 basis points.

Asset class performance in the first and second six months after the Fed started its easing policy from 1995 to 1996

Source: Bloomberg, as of September 3, 2024.

Currently, the trading prices of the U.S. stock market are higher than its historical average valuation levels, perhaps digesting the upcoming rate cut cycle. Therefore, he believes that the stock market will not experience a significant increase similar to the rate cut cycle in 1996.

For stock investors, it is wise to adopt a more defensive stock deployment. Similar to the 1995 cycle, in this easing cycle, defensive stocks such as healthcare and value stocks are expected to outperform growth stocks.

Although strong earnings from the largest artificial intelligence chip maker failed to boost the market, the AI frenzy seems to have stalled. The market is likely taking a wait-and-see attitude towards AI, especially regarding whether it can achieve breakthroughs in productivity.

While the Fed's rate cuts help alleviate market tension and should boost local currencies and risk assets in emerging markets, the positive effects may be offset by softening economic growth in both China and the U.S. Overall, while maintaining an optimistic view, a slowdown in the U.S. economy is expected over the next few quarters. Despite the cooling U.S. economy, other major economies have not picked up the growth baton.

The upcoming rate cut cycle in the U.S. is likely to be interrupted due to anti-inflationary forces and weak growth. Continued rate cuts, moderate energy prices, and a weaker U.S. dollar should prevent the U.S. economy from falling into a recession. However, policy uncertainty is likely to intensify, especially before the U.S. presidential election, which may mean that companies delay capital expenditures and investments.

In this environment, he continues to believe that adopting a defensive deployment is a wise move