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Higher rates, lower equities

October 19, 2023
clock 3 MIN READ

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- Hello, I'm Vivian Estadt, Client Service Director at SEI. I'm here with Chief Market Strategist and Senior Portfolio Manager, Jim Solloway, to provide a quick preview of one of the timely topics he covers in our most recent economic outlook. Equities markets defied gravity in the first half of 2023, and were seemingly immune to the dampening effects of high inflation and interest rates. In recent weeks, equities have appeared to pull back somewhat. Jim, is this the beginning of a market reversal?

- Thanks, Vivian. Yes, we believe equity markets have entered a corrective phase. The big tech growth stocks are likely more vulnerable than the overall market. The price correction probably has more to go, but we don't expect it to deteriorate into a bear market.

- What's driving the downward movement?

- There are several factors, one of which is the upward shift in bond yields in response to the Fed's stance in keeping interest rates high to help curb inflation. The effect here is twofold. When longer term bond yields rise, future earnings become less valuable to investors. Moreover, when interest rates rise, it becomes more expensive for businesses to borrow and make investments that fuel future growth. The outcome is that the present-day value of companies, demonstrated by earnings multiples, and by extension, their stock prices, starts to decline. In our view, the S&P 500 as a whole remains highly valued. Equities have moved lower over the past two months, but there may be further price declines ahead. We think analyst earnings estimates in the year ahead may prove to be too high, especially if economic growth stalls and a recession develops. Moreover, we maintain our view that large multinational companies will face a number of challenges that will make it difficult to maintain the record high profit margins they have enjoyed.

- Given that outlook, what's your view on US large cap stocks?

- We realize that the US large caps have consistently outperformed the rest of the world for a long time. At the moment, we think that earnings estimates are perhaps too high, and there is a dislocation between valuations and the sharp rise in bond yields. Together, that makes a worrisome combination. Diversification across asset classes and across geographies is in our view, a better strategy than focusing on the high-flying tech stocks or the market capitalization weighted S&P 500 more generally.

- Thanks, Jim. We always appreciate your insights. SEI is focused on the major issues that are of interest to our clients. We incorporate these discussions into our advisory process as the impact varies based on each client's goals. For more of SEI's insights, read our latest economic outlook available on our website.

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