As the supply of bonds and equities has grown, markets have followed the oldest rule in economics: when supply exceeds demand, the buyer sets the terms.
This “buyer’s market” may seem counterintuitive with global equity markets at or near record levels. Investors are also awash in liquidity: U.S. money market funds hold $7.9 trillion.1 Record prices and abundant liquidity usually point to froth, not discipline, and some investors worry that equities may be inadequately reflecting the impact of higher rates.
But beneath the headline levels, we see a market that is reasonably rational about where capital goes, including the adversity of higher yields. A number of companies are already feeling the headwinds, even if the major cap-weighted indices show little strain. Buyers are calling the terms by incrementally demanding lower price-to-earnings ratios and higher yields rather than chasing momentum embedded in strong economic and earnings growth.
The appeal of cash amid growing unknowns partly explains investor patience. With cash offering a healthy yield, investors face less pressure to put money to work.
No Longer a Blind Beta Market
The buyer’s market mentality reinforces our outlook: stay selectively invested while adjusting risk at the margin. The broad beta drivers that propelled equities have faded, and this quarter the Asset Allocation Committee took our multi-year equity overweight down to target. Higher rates have made the market more complicated, contributing to the valuation de-rating we discussed recently. The pressure is not falling evenly: this is increasingly a market of haves and have-nots.
Poor breadth makes the point. Despite record index highs, 56% of Russell 2000 constituents sit at least 20% below their one-year highs, as do 39% of S&P 500 members.2 A record index can coexist with meaningful drawdowns beneath it, giving buyers a wide range of valuations and business prospects to assess.
Some examples of where the pressure is showing:
- Financing-sensitive businesses. Companies reliant on refinancing or floating-rate debt feel higher costs directly.
- Stretched consumers. Companies serving middle- and lower-income households face customers absorbing higher borrowing and living costs.
- Strong growth stories. A more discerning market gravitates to businesses whose return on equity is well above the higher cost of capital. Higher rates matter much less to them. A lower share price has to be weighed against fundamentals and, while some companies are cheaper for good reason, others may offer real opportunity.
This environment offers potential because it is fundamentally driven. July was a more technical market, with AI-levered tech swinging wildly as leveraged and retail players set the tone. Some pockets remain, but news is now generally priced appropriately, not chased out of greed.
Bond Market Complexities
Fixed income tells a similar story. Investors are demanding more yield and/or spread from borrowers whose financing needs stretch their ability to repay.
- Investment grade corporates. Credits with stretched balance sheets or higher-stakes acquisitions have struggled recently, with spreads widening materially. Creditworthiness matters, and investors are asking whether each issuer’s cash flows justify its borrowing and the price paid for its debt.
- Lower-quality high yield. Spreads on CCC rated and lower debt (the extra yield investors demand over Treasuries) have widened to 998 basis points, the widest since March 2023.3 Investors want more compensation where borrowers have less room for error.
- Sovereigns. Governments are also scrutinized when investors question the sustainability of their financing. France and Italy are top of mind, but other issuers may be vulnerable.
These developments indicate a market executing discipline name by name and sector by sector, and pricing risk appropriately, healthy indicators of fundamentals winning in fixed income in parallel with equities.
Fully Invested, But More Selective
We are mindful of equity risk and have reduced exposure. We are looking closely at the businesses we own, with a bias to quality and U.S. large caps. We have taken overweight chips off the table in small caps and emerging markets. In both, we maintain actively managed allocations to names that tend to be more profitable and less levered than the index.
On bonds, upside risks to yields remain, but we still think the market is priced too hawkishly, particularly in the U.S. and perhaps Europe. Last week’s benign U.S. payroll report took some hikes out of the market. Disinflation is slower than central banks would like, but it remains on track. The rise in yields has been appropriate relative to the growth and risk profile. What is being punished are specific credits and sovereigns with weak exposures of their own.
We have cut risk at the margin, but we are by no means bearish on risk assets. With cash earning a healthy yield, investors can wait for conviction, and the market is rewarding those who do the work. That is the benefit of a buyer’s market.
What to Watch For
Monday 10/12:
- Japan: Producer Price Index
- Japan: Bank Lending
- U.K.: Retail Sales
Tuesday 10/13:
- U.S.: Small Business Optimism
- U.S.: Home Sales
- U.S.: Federal Budget Balance
- Japan: Money Supply
- China: Consumer/Producer Price Index
Wednesday 10/14:
- U.S.: Consumer Price Index
- U.S.: Real Earnings
