A CIO managing $40 million warns most stock-market investors are in danger of losses as high interest rates begin to stifle the economy and risk-free Treasury yields offer 5%
- Mulholland & Kuperstock’s Stephen Mulholland believes it is time to reduce equity exposure.
- Mulholland is reducing his fund’s stock exposure by 50%.
- He predicted that Treasury rates of 5% would continue to entice investors away from stocks.
According to Stephen Mulholland, now is probably a good time to reduce stock market exposure.
Mulholland & Kuperstock’s CIO, who manages $40 million in assets, announced last week that he is cutting stock-market exposure in the firm’s fund, the MKAM ETF (MKAM), in half, from 32% to 16%.
He gave two reasons for this: Risk-free Treasury yields are now much more appealing than they have been in recent decades, and the economy is bound to slow as the Federal Reserve maintains high interest rates.
Treasury rates are now rising across the board as the yield curve flattens out, with longer-term rates continuing to rise. As of Friday afternoon, annualized yields for various durations were as follows:
- 3-month bill: 5.43%
- 1-year bill: 5.29%
- 2-year note: 4.84%
- 10-year note: 4.57%
Treasury bonds are considered risk-free investments because they are backed by the United States government, which has never defaulted on its debt payments. Mulholland believes stocks will face headwinds in the future due to bonds’ lack of risk and the substantial returns they currently offer, as well as how richly stocks are valued.
The current equity-risk premium is the amount that the S&P 500 is expected to return over the next decade in excess of the 10-year Treasury note. It’s currently below 1%, the lowest in two decades and approaching levels seen during the dot-com bubble.
“Investors are awakening to a new day in which they can finally earn a safe return in cash and bonds.” In a recent note, Mulholland stated that “US Treasury Bills pay more than their historical average, at 5.5%.””Stocks remain the outlier, priced for the old world, where investors had to take risks to generate returns.”
Concerning the effects of higher interest rates on the economy, Mulholland stated that they would continue to manifest themselves in a variety of ways.
One is a housing-market stalemate, with prospective sellers hesitant to exit their low-interest mortgages and buyer affordability being the worst in four decades by many measures. Home improvements would also slow as interest rates rose, he predicted.
Mulholland believes that as interest rates rise, businesses will be less likely to borrow money to expand as much, and banks will be less likely to lend money. According to data from the Federal Reserve’s Senior Loan Officer Opinion Survey, roughly half of banks are now tightening lending standards for small-business loans. This is also true for large corporations.
Given his bearish outlook for stocks, Mulholland predicted that most investors would be in trouble because they are more invested in stocks than in bonds. He advised investors who may need access to their money in the stock market in the near future to move it to short-term Treasury bills.
“Investors who make regular withdrawals or have large liquidity needs on the horizon would be smart to reduce stock market exposure now,” Mulholland said in a statement. “It’s obvious the economy will slow and that the general direction for the stock market is down.”
Will there be a recession?
The jury is still out on whether the Fed’s aggressive hiking cycle will cause the US economy to enter a downturn.
Indicators are sending conflicting signals about the economy’s strength. For example, the United States reported 4.9% year-on-year GDP growth in the third quarter, a historically high figure in pre-COVID terms and significantly higher than the 2.1% growth in Q2.
However, the Bureau of Labor Statistics reported on Friday that the US added only 150,000 jobs in October, falling short of economists’ expectations of 180,000. The numbers for September and August were also revised downward by tens of thousands of jobs, and the unemployment rate rose to 3.9% from 3.8%, which is still historically low.
The Treasury yield curve and The Conference Board’s Leading Economic Index, both widely followed recession indicators, continue to point to a coming downturn. However, if the labor market and the American consumer can hold out as the Fed appears to be nearing the end of its hike cycle, the central bank may achieve its goal of a soft landing.
According to a Reuters poll conducted in August, 40% of economists predicted a recession in the next 12 months. This was a decrease from 65% in October 2022.
Stock performance is heavily influenced by how the economy performs in the coming months, as well as where interest rates go. A significant deterioration in earnings performance or in the labor market could spell trouble.
Regardless, with the S&P 500 already up 14% year to date, stocks may have limited upside for the rest of the year.
