Equities vs. Bonds: Navigating the Unemployment Rollercoaster
Equities and bonds are two of the most common investment types that people consider when looking to invest their money. The performance of these two assets is often compared to the current state of the economy, particularly in relation to the unemployment rate. When the economy is experiencing low ERP [Equity Risk Premium] levels and an increase in unemployment rates, it is generally observed that equities tend to perform worse than bonds.
Low ERP levels imply that investors are not receiving an adequate return on investment for the additional risk they are taking by investing in equities compared to bonds. In addition, increasing unemployment rates often indicate a slowing economy, which can lead to decreased company profits and lower stock prices. As a result, investors may be hesitant to take on additional risk by investing in equities and may prefer to invest in safer assets such as bonds.
However, it's important to note that there are times when the potential returns of moving towards a riskier investment strategy may be worth the risks associated with late-cycle economic conditions. If there is positive momentum for the growth and inflation mix, it can lead to better returns for equities even in such conditions.
When considering global equities, investors must keep in mind several factors that can affect their performance. The first factor to consider is the declining SPX [S&P 500 Index] forward earnings. This implies that the projected future earnings of companies listed on the S&P 500 Index are decreasing. The second factor is an inverted yield curve, where short-term interest rates are higher than long-term interest rates. This inversion often indicates an economic recession.
The third factor to consider is below-average unemployment rates. This suggests that the economy may be overheating, which can lead to inflation and interest rate hikes by central banks, which in turn can lead to a downturn in equity markets. The fourth factor is manufacturing PMIs [Purchasing Managers' Index] below 50, which indicate a contraction in manufacturing activity. Finally, the fifth factor is 40% of banks tightening their lending standards, which can lead to reduced credit availability and a decrease in economic growth.
It is rare for all five of these factors to be present simultaneously, but unfortunately, this is the case today. Therefore, investors need to keep a close eye on these factors and adjust their investment strategies accordingly. Understanding the current economic conditions and how they relate to equities and bonds is essential for successful investment decision-making.
