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Capital IdeasTM

Investment insights from Capital Group

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Equity
The road ahead for equities
Katharine Dryer
Head of Equity Business Development
Andy Budden
Investment Director

What direction could equity markets take from here? Will they continue on a narrow path - led by large-cap tech stocks - or is there potential for a wider range of opportunities?


The US Federal Reserve (Fed) cut rates at its September meeting and history tells us that when a subsequent recession does not materialise, it is a good time to invest in equities.


Our analysis of historical periods suggests it is not uncommon for technology stocks to outpace other areas of the equity market in environments similar to the one we are experiencing; specifically, the period before the first Fed rate cut. Following that, in a soft-landing scenario, there is evidence that markets tend to broaden. However, central to that analysis is that the US avoids recession.


Can the US avoid a recession?


While forecasting recessions is notoriously difficult, we think there are multiple factors supporting a more optimistic outcome over the next 12-months. A robust labour market, stimulus from the IRA/CHIPS Acts1, and signs that US consumers and borrowers have already borne the brunt of higher rates are just some of the indicators that point to the US avoiding a recession. Capital Group economist Jared Franz sees the potential for a ‘Benjamin Button’ scenario for the US economy, where instead of moving from late-cycle into recessionary territory, it returns to the mid-cycle stage.


Of course, there remain reasons to be cautious. The excess savings created during the pandemic are now dwindling across advanced economies, which could contribute to weakening consumer expectations.


Equity market leadership could broaden out following a Fed rate cut


We looked at rate-cutting cycles since 1982, in recessionary and non-recessionary periods, and tracked how different sectors reacted.


In the previous seven Fed-induced rate cutting cycles, three easing cycles occurred in non-recessionary periods and four took place during recessions.


We analysed both situations, splitting the cutting-cycle into two parts; the peak to first rate cut, and the first rate cut to the last rate cut.


Average S&P 500 Index returns: Recession vs non-recession since 1982 

Peak rates to first rate cut vs first cut to last cut

Peak rates to first rate cut vs first cut to last cut

Past results are not a guarantee of future results.

Data calculated on rate cutting periods from 1982 to March 2020. Source: Bloomberg, Capital Strategy Research. Last seven rate cutting cycles: three during non-recessionary periods, four during recessionary periods

What can we deduce from this analysis? In the event of a soft landing, there is the potential for a broader range of companies and sectors to do well, and potentially outpace technology stocks.


What are the investment implications?


Longer-term trends in the global energy transition, health care developments such as obesity drugs, and the realignment of global supply chains suggest interesting opportunities remain outside of Big Tech.


That’s not to say that technology stocks or US companies should be avoided. There remain a range of technology companies where our portfolio managers and analysts believe in their potential to deliver strong returns. There is also the longer-term potential for AI to profoundly impact a wide range of companies from various industries. Active investors can stand to benefit by identifying the future winners across the AI stack, while being mindful of valuation and concentration risks within their portfolios.


A strategy that is not overly exposed to a particular sector or theme, but constructed with a broader mindset may fare well as it has the potential to benefit from a wider range of economic drivers.


Overall, while it will not be one-way traffic, the road ahead for equities appears to be veering closer towards an open highway than a narrow lane.


1. IRA: Inflation Reduction Act, CHIPS and Science Act: Creating Helpful Incentives to Produce Semiconductors and Science Act



Katharine Dryer is Head of Equity Business Development for the Europe and Asia Client Group. She has 25 years of investment industry experience and has been with Capital Group for 1 year. She holds a master’s degree in modern and medieval languages from the University of Oxford, and an MBA from Cass Business School. Katharine is based in London.

Andy Budden is an Investment Director at Capital Group. He has 30 years of investment industry experience and has been with Capital Group for 19 years. Earlier in his career at Capital, he was an investment specialist. He holds both a master’s degree and a bachelor’s degree in engineering from the University of Cambridge. He is an associate member of the Institute of Actuaries. Andy is based in Singapore.


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Past results are not predictive of results in future periods. It is not possible to invest directly in an index, which is unmanaged. The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment. This information is not intended to provide investment, tax or other advice, or to be a solicitation to buy or sell any securities.

Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. All information is as at the date indicated unless otherwise stated. Some information may have been obtained from third parties, and as such the reliability of that information is not guaranteed.

Capital Group manages equity assets through three investment groups. These groups make investment and proxy voting decisions independently. Fixed income investment professionals provide fixed income research and investment management across the Capital organization; however, for securities with equity characteristics, they act solely on behalf of one of the three equity investment groups.