Multi-Asset Strategies Outlook
Is the Economy Headed for a Hard or Soft Landing?
From the beginning of the tightening campaign to tame inflation, market participants have pondered which economic scenario would play out: a hard landing or a soft landing.
The economic hard-landing scenario involves an economy that careens into recession, while stocks and economically sensitive corporate bonds struggle. A soft landing would mean that the economy continues to grow — even if only modestly — while inflation moderates, allowing stocks and bonds to continue to do well.
Soft Landing Case Rests on Backward-Looking Data
The argument for a soft landing rests on several pillars. These include better-than-expected corporate earnings, a strong labor market, continued steady consumer spending and a slowdown in the rate of inflation. The important thing to note about these statistics, however, is that they’re all backward looking. They’re useful for telling us where we’ve been, but less good at indicating where we’re going.
Indeed, the Federal Reserve’s (Fed’s) own GDPNow estimate of third-quarter growth based on current economic indicators is 5.6%. Note that it’s called a “nowcast” as opposed to a forecast because it relies on already observed variables without factoring in expectations for future figures.
In our view, the fact that it is based on historical data and doesn’t include any forward estimates is precisely the disconnect between the hard and soft landing camps. For example, contrast that 5.6% number with the sub-2% forecast of leading economists shown in the Blue Chip Financial Forecasts.
Hard-Landing Argument Is Broad-Based
In contrast, many of the best forward-looking indicators we know are pointing down. The yield curve (a graphic representation of bond yields at different maturities) is pointing down, the housing market faces an affordability crisis and manufacturing activity has declined for nine straight months through July. Any one of these would be a flashing economic warning signal, but all three together make an ominous sign.
But perhaps the single most important argument for a hard landing ahead is the lagged effect of Fed rate hikes. A good rule of thumb is that it takes around 18 months for the Fed’s rate changes to show up in the real economy. It turns out that the Fed’s first hike in this cycle was in March 2022, or exactly 18 months ago.
If the effect of the Fed’s rate increases flows into the economy gradually over 18 months, then fully a third of the Fed’s rate hikes are yet to be felt. The long lag between policy changes and economic effect is a key reason why we believe the recession is still ahead of us.
Explore Our Outlook
We maintain a strong preference for cash relative to bonds and some stocks. An inverted yield curve necessarily means that cash and shorter-term investments offer attractive yields relative to longer-term bonds. Cash yields also look compelling relative to stock earnings yields. In addition, stock market momentum stalled in August, further reducing equities’ appeal. Qualitatively, negative leading economic indicators also cloud the outlook for stocks relative to alternative, safer investments, like cash. Within equities we are emphasizing an underweight to real estate investment trusts (REITs).
We recently closed out our beneficial overweight to non-U.S. developed market equities relative to U.S. stocks. Our momentum metrics favor the U.S. over European equities, while relative interest rates favor Europe. Real rates in the EU are negative, which supports risk assets. But in the U.S., real rates are flat or positive, depending on which measure of inflation you use. The net effect of these factors is that we’re neutral for now.
We have returned to neutral on emerging markets after benefiting from an overweight to U.S. equities in recent months. In our view, macro conditions favor U.S. equity while credit and company fundamentals favor emerging markets at the margin, rendering a neutral reading. China remains a question mark. Growth there is disappointing, but the country’s leaders appear to want to strike a balance between doing too little and unleashing another huge wave of stimulus.
U.S. Equity Size & Style
Our small/large model is close to neutral on every dimension we measure, from relative valuations, earnings and sentiment to a range of macroeconomic indicators. From a qualitative point of view, it’s hard to favor small-cap stocks when we believe a recession is likely. In such a scenario, large multinationals would be more attractive for their diversified markets and lines of business.
We recently removed our value overweight, which was beneficial in 2022 but detracted in 2023. This environment points up the importance of individual security selection. From a growth point of view, the dominance of the “magnificent seven” have distorted the performance picture for growth stocks more broadly. Value, too, has had performance challenges resulting from a single sector — banks. These conditions create opportunities in less-appreciated businesses across both growth and value.
Recession remains the most likely outcome in our view, and we expect this will eventually weigh on corporate bonds. In most scenarios, we see inflation remaining above historical trend levels. As a result, we still see the best value in the short end of the inflation curve. The Fed is likely nearing the end of its tightening cycle. Once hikes are complete we expect an extended pause unless a new crisis emerges. The market likely will factor in rate cuts once it becomes confident the Fed has reached its peak rate.
Within equities, our highest conviction position is an underweight to REITs. Our global REITs managers continue to find relative value opportunities by region and sector and from security to security. But broadly speaking, economic uncertainty presents fundamental challenges for REITs at a time when cash yields, in particular, are so compelling. Our long-running REITs underweight has been a significant contributor over time.
View Glossary Definitions
A form of securitized debt that represents ownership in pools of mortgage loans and their payments.
Asset-backed securities (ABS)
A form of securitized debt (defined below), ABS are structured like mortgage-backed securities (MBS, defined below). But instead of mortgage loans or interest in mortgage loans, the underlying assets may include such items as auto loans, home equity loans, student loans, small business loans, and credit card debt. The value of an ABS is affected by changes in the market's perception of the assets backing the security, the creditworthiness of the servicing agent for the loan pool, the originator of the loans, or the financial institution providing any credit enhancement.
BB and BBB credit rating
Securities and issuers rated AAA to BBB are considered/perceived “investment-grade”; those rated below BBB are considered/perceived non-investment-grade or more speculative.
Beta is a standard measurement of potential investment risk and return. It shows how volatile a security's or an investment portfolio's returns have been compared with their respective benchmark indices. A benchmark index's beta always equals 1. A security or portfolio with a beta greater than 1 had returns that fluctuated more, both up and down, than those of its benchmark, while a beta of less than 1 indicates less fluctuation than the benchmark.
Entity responsible for oversight of a nation’s monetary system, including policies and interest rates.
Collateralized loan obligations (CLOs)
A form of securitized debt, typically backed by pools of corporate loans and their payments.
Commercial Mortgage-Backed Securities (CMBS)
MBS that represent ownership in pools of commercial real estate loans used to finance the construction and improvement of income-producing properties, including office buildings, shopping centers, industrial parks, warehouses, hotels, and apartment complexes.
Short-term debt issued by corporations to raise cash and to cover current expenses in anticipation of future revenues.
Commodities are raw materials or primary agricultural products that can be bought or sold on an exchange or market. Examples include grains such as corn, foods such as coffee, and metals such as copper.
Consumer Price Index (CPI)
CPI is the most commonly used statistic to measure inflation in the U.S. economy. Sometimes referred to as headline CPI, it reflects price changes from the consumer's perspective. It's a U.S. government (Bureau of Labor Statistics) index derived from detailed consumer spending information. Changes in CPI measure price changes in a market basket of consumer goods and services such as gas, food, clothing, and cars. Core CPI excludes food and energy prices, which tend to be volatile.
Corporate securities (corporate bonds and notes)
Debt instruments issued by corporations, as distinct from those issued by governments, government agencies, or municipalities. Corporate securities typically have the following features: 1) they are taxable, 2) they tend to have more credit (default) risk than government or municipal securities, so they tend to have higher yields than comparable-maturity securities in those sectors; and 3) they are traded on major exchanges, with prices published in newspapers.
Correlation measures the relationship between two investments--the higher the correlation, the more likely they are to move in the same direction for a given set of economic or market events. So if two securities are highly correlated, they will move in the same direction the vast majority of the time. Negatively correlated investments do the opposite--as one security rises, the other falls, and vice versa. No correlation means there is no relationship between the movement of two securities--the performance of one security has no bearing on the performance of the other. Correlation is an important concept for portfolio diversification--combining assets with low or negative correlations can improve risk-adjusted performance over time by providing a diversity of payouts under the same financial conditions.
Credit quality reflects the financial strength of the issuer of a security, and the ability of that issuer to provide timely payment of interest and principal to investors in the issuer's securities. Common measurements of credit quality include the credit ratings provided by credit rating agencies such as Standard & Poor's and Moody's. Credit quality and credit quality perceptions are a key component of the daily market pricing of fixed-income securities, along with maturity, inflation expectations and interest rate levels.
Measurements of credit quality (defined below) provided by credit rating agencies (defined below). Those provided by Standard & Poor's typically are the most widely quoted and distributed, and range from AAA (highest quality; perceived as least likely to default) down to D (in default). Securities and issuers rated AAA to BBB are considered/perceived to be "investment-grade"; those below BBB are considered/perceived to be non-investment-grade or more speculative.
A debt instrument, including bonds, certificates of deposit or preferred stocks.
Deflation is the opposite of inflation (see Inflation); it describes a decline in prices for goods, assets and services, and is considered a highly undesirable economic outcome by economists and policymakers.
Occurs when the investor or fund manager uses techniques attempting to prevent a decrease in the value of the investment.
Duration is an important indicator of potential price volatility and interest rate risk in fixed income investments. It measures the price sensitivity of a fixed income investment to changes in interest rates. The longer the duration, the more a fixed income investment's price will change when interest rates change. Duration also reflects the effect caused by receiving fixed income cash flows sooner instead of later. Fixed income investments structured to potentially pay more to investors earlier (such as high-yield, mortgage, and callable securities) typically have shorter durations than those that return most of their capital at maturity (such as zero-coupon or low-yielding noncallable Treasury securities), assuming that they have similar maturities.
The eurozone is sometimes referred to as the euro area and represents the member states that participate in the economic and monetary union (EMU) with the European Union (EU). The eurozone currently consists of: Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.
Federal funds rate (aka fed funds rate)
The federal funds rate is an overnight interest rate banks charge each other for loans. More specifically, it's the interest rate charged by banks with excess reserves at a Federal Reserve district bank to banks needing overnight loans to meet reserve requirements. It's an interest rate that's mentioned frequently within the context of the Federal Reserve's interest rate policies. The Federal Reserve's Open Market Committee (defined below) sets a target for the federal funds rate (which is a key benchmark for all short-term interest rates, especially in the money markets), which it then supports/strives for with its open market operations (buying or selling government securities).
Federal Reserve (Fed)
The Fed is the U.S. central bank, responsible for monetary policies affecting the U.S. financial system and the economy.
Investment "fundamentals," in the context of investment analysis, are typically those factors used in determining value that are more economic (growth, interest rates, inflation, employment) and/or financial (income, expenses, assets, credit quality) in nature, as opposed to "technicals," which are based more on market price (into which fundamental factors are considered to have been "priced in"), trend, and volume factors (such as supply and demand), and momentum. Technical factors can often override fundamentals in near-term investor and market behavior, but, in theory, investments with strong fundamental supports should maintain their value and perform relatively well over long time periods.
Gross domestic product
Gross domestic product (or GDP) is a measure of the total economic output in goods and services for an economy.
High-yield bonds are fixed income securities with lower credit quality and lower credit ratings. High-yield securities are those rated below BBB- by Standard & Poor's.
Inflation, sometimes referred to as headline inflation, reflects rising prices for consumer goods and services, or equivalently, a declining value of money. Core inflation excludes food and energy prices, which tend to be volatile. It is the opposite of deflation (see Deflation).
Debt securities that offer returns adjusted for inflation; a feature designed to eliminate the inflation risk.
Investment-grade corporate bond or credit
A debt security with a relatively low risk of default issued and sold by a corporation to investors.
Liquidity describes the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset's price.
Mortgage-backed securities (MBS)
A form of securitized debt (defined below) that represents ownership in pools of mortgage loans and their payments. Most MBS are structured as "pass-throughs"--the monthly payments of principal and interest on the mortgages in the pool are collected by the financial entity that is servicing the mortgages and are "passed through" monthly to investors. The monthly and principal payments are key differences between MBS and other bonds such as Treasuries, which pay interest every six months and return the whole principal at maturity. Most MBS are issued or guaranteed by the U.S. government, a government-sponsored enterprise (GSE), or by a private lending institution.
These are long-term municipal securities (defined below) with maturities of 10 years or longer.
Municipal securities (munis)
Debt securities typically issued by or on behalf of U.S. state and local governments, their agencies or authorities to raise money for a variety of public purposes, including financing for state and local governments as well as financing for specific projects and public facilities. In addition to their specific set of issuers, the defining characteristic of munis is their tax status. The interest income earned on most munis is exempt from federal income taxes. Interest payments are also generally exempt from state taxes if the bond owner resides within the state that issued the security. The same rule applies to local taxes. Another interesting characteristic of munis: Individuals, rather than institutions, make up the largest investor base. In part because of these characteristics, munis tend to have certain performance attributes, including higher after-tax returns than other fixed income securities of comparable maturity and credit quality and low volatility relative to other fixed-income sectors. The two main types of munis are general obligation bonds (GOs) and revenue bonds. GOs are munis secured by the full faith and credit of the issuer and usually supported by the issuer's taxing power. Revenue bonds are secured by the charges tied to the use of the facilities financed by the bonds.
For most bonds and other fixed-income securities, nominal yield is simply the yield you see listed online or in newspapers. Most nominal fixed-income yields include some extra yield, an "inflation premium," that is typically priced/added into the yields to help offset the effects of inflation (see Inflation). Real yields (see Real yield), such as those for TIPS (see TIPS), don't have the inflation premium. As a result, nominal yields are typically higher than TIPS yields and other real yields.
Non-agency commercial mortgage-backed securities (CMBS)
MBS that represent ownership in pools of commercial real estate loans used to finance the construction and improvement of income-producing properties. Non-agency CMBS are not guaranteed by the U.S. government or a government-sponsored enterprise.
Price to earnings ratio (P/E)
The price of a stock divided by its annual earnings per share. These earnings can be historical (the most recent 12 months) or forward-looking (an estimate of the next 12 months). A P/E ratio allows analysts to compare stocks on the basis of how much an investor is paying (in terms of price) for a dollar of recent or expected earnings. Higher P/E ratios imply that a stock's earnings are valued more highly, usually on the basis of higher expected earnings growth in the future or higher quality of earnings.
Nationally recognized statistical rating organizations assign quality ratings to reflect forward-looking opinions on the creditworthiness of loan issuers.
Real estate investment trusts (REITs)
Real estate investment trusts (REITs) are securities that trade like stocks and invest in real estate through properties or mortgages.
For most bonds and other fixed-income securities, real yield is simply the yield you see listed online or in newspapers (see Yield) minus the premium (extra yield) added to help counteract the effects of inflation (see Inflation). Most "nominal" fixed-income yields (see Nominal yield) include an "inflation premium" that is typically priced into the yields to help offset the effects of inflation. Real yields, such as those for TIPS, don't have the inflation premium. As a result, TIPS yields and other real yields are typically lower than most nominal yields.
Russell 1000® Growth Index
Measures the performance of those Russell 1000 Index companies (the 1,000 largest publicly traded U.S. companies, based on total market capitalization) with higher price-to-book ratios and higher forecasted growth values.
Russell 1000® Value Index
Measures the performance of those Russell 1000 Index companies (the 1,000 largest publicly traded U.S. companies, based on total market capitalization) with lower price-to-book ratios and lower forecasted growth values.
S&P 500® Growth Index
A style-concentrated index designed to track the performance of stocks that exhibit the strongest growth characteristics by using a style-attractiveness weighting scheme.
S&P 500® Index
The S&P 500® Index is composed of 500 selected common stocks most of which are listed on the New York Stock Exchange. It is not an investment product available for purchase.
S&P 500® Value Index
The S&P 500 Value Index is a style-concentrated index that measures stocks in the S&P 500 using three factors: the ratios of book value, earnings, and sales to price. It is not an investment product available for purchase.
Debt resulting from the process of aggregating debt instruments into a pool of similar debts, then issuing new securities backed by the pool (securitizing the debt). Asset-backed and mortgage-backed securities (ABS and MBS, defined further above) and collateralized mortgage obligations (CMOs, defined above) are common forms of securitized debt. The credit quality (defined above) of securitized debt can vary significantly, depending on the underwriting standards of the original debt issuers, the credit quality of the issuers, economic or financial conditions that might affect payments, the existence of credit backing or guarantees, etc.
A security that has a higher priority compared to another in the event of liquidation.
A country's own government-issued debt, priced in its native currency, that can be sold to investors in other countries to raise needed funds. For example, U.S. Treasury debt is U.S. sovereign debt, and would be referred to as sovereign debt when bought by foreign investors. Conversely, debt issued by foreign governments and priced in their currencies would be sovereign debt to U.S. investors.
Spreads (aka "interest-rate spreads", "maturity spreads," "yield spreads" or "credit spreads")
In fixed income parlance, spreads are simply measured differences or gaps that exists between two interest rates or yields that are being compared with each other. Spreads typically exist and are measured between fixed income securities of the same credit quality (defined above), but different maturities, or of the same maturity, but different credit quality. Changes in spreads typically reflect changes in relative value, with "spread widening" usually indicating relative price depreciation of the securities whose yields are increasing most, and "spread tightening" indicating relative price appreciation of the securities whose yields are declining most (or remaining relatively fixed while other yields are rising to meet them). Value-oriented investors typically seek to buy when spreads are relatively wide and sell after spreads tighten.
Spread sectors (aka "spread products," "spread securities")
In fixed income parlance, these are typically non-Treasury securities that usually trade in the fixed income markets at higher yields than same-maturity U.S. Treasury securities. The yield difference between Treasuries and non-Treasuries is called the "spread" (defined further above), hence the name "spread sectors" for non-Treasuries. These sectors--such as corporate-issued securities and mortgage-backed securities (MBS, defined above)--typically trade at higher yields (spreads) than Treasuries because they usually have relatively lower credit quality (defined above) and more credit/default risk (defined above), and/or they have more prepayment risk (defined above).
Stagflation describes slowing economic growth combined with high inflation.
An unsecured loan or bond that ranks below more senior loans in terms of claims on assets or earnings.
Treasury inflation-protected securities (TIPS)
TIPS are a special type of U.S. Treasury security designed to address a fundamental, long-standing fixed-income market issue: that the fixed interest payments and principal values at maturity of most fixed-income securities don't adjust for inflation. TIPS interest payments and principal values do. The adjustments include upward or downward changes to both principal and coupon interest based on inflation. TIPS are inflation-indexed; that is, tied to the U.S. government's Consumer Price Index (CPI). At maturity, TIPS are guaranteed by the U.S. government to return at least their initial $1,000 principal value, or that principal value adjusted for inflation, whichever amount is greater. In addition, as their principal values are adjusted for inflation, their interest payments also adjust.
A treasury note is a debt security issued by the U.S. government with a fixed interest rate and maturity ranging from one to 10 years.
The yield (defined below) of a Treasury security (most often refers to U.S. Treasury securities issued by the U.S. government).
A quantitative estimate of a company or asset’s value.
For bonds and other fixed-income securities, yield is a rate of return on those securities. There are several types of yields and yield calculations. "Yield to maturity" is a common calculation for fixed-income securities, which takes into account total annual interest payments, the purchase price, the redemption value, and the amount of time remaining until maturity.
A line graph showing the yields of fixed income securities from a single sector (such as Treasuries or municipals), but from a range of different maturities (typically three months to 30 years), at a single point in time (often at month-, quarter- or year-end). Maturities are plotted on the x-axis of the graph, and yields are plotted on the y-axis. The resulting line is a key bond market benchmark and a leading economic indicator.
References to specific securities are for illustrative purposes only, and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.
International investing involves special risk considerations, including economic and political conditions, inflation rates and currency fluctuations.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
Historically, small- and/or mid-cap stocks have been more volatile than the stock of larger, more-established companies. Smaller companies may have limited resources, product lines and markets, and their securities may trade less frequently and in more limited volumes than the securities of larger companies.
Diversification does not assure a profit nor does it protect against loss of principal.
Generally, as interest rates rise, bond prices fall. The opposite is true when interest rates decline.
Past performance is no guarantee of future results. Investment returns will fluctuate and it is possible to lose money.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.