High rates could derail year-end stocks rally, BlackRock says

Research chief says rates outlook has not been reflected in equities yet.

Any year-end rally in stocks could prove short-lived because equities don’t fully reflect the outlook for rates remaining higher for longer, according to Jean Boivin, who heads the research arm at BlackRock Inc.

Treasury yields have climbed to multi-year highs as investors prepare for an extended period of tightened Federal Reserve monetary policy, a pattern that history shows tends to have a negative correlation with stocks.

“The question we ask is if the surge in rates has fed through to equities, and our answer is not yet,” said Boivin, a former Bank of Canada official who now heads the BlackRock Investment Institute. “We think there’s more downward adjustment to come, but we expect to see a better environment in 2024 once the adjustment is complete,” he said in an interview in London last week.

Boivin’s team has remained underweight broad developed-market equities on a tactical basis since July 2022 — even through an 11% rally in the MSCI World Index over that time. The reasoning is two-pronged: firstly, he expects global growth to stagnate over the coming year as the US economy “is weaker than it appears,” and secondly, equities don’t reflect the higher rate environment he sees persisting.

“If it turns out that we’re wrong and there’s a material pick up in economic growth or a sustained pullback in rates, that would prompt us to become more optimistic on stocks,” the strategist said.

Market action in early November has certainly contrasted with Boivin’s expectations. The S&P 500 Index clocked its best weekly gain in a year and the 10-year bond yield fell further back from 5% following signs that the Federal Reserve could soften its policy outlook. The chorus of investors and strategists expecting a year-end rally has strengthened on wagers of a peak in rates and support from seasonal trends.

The benchmark S&P 500 remains about 14% higher year-to-date, with most of those gains concentrated in technology behemoths after gains spurred by optimism around artificial intelligence.

While Boivin is also bullish about the impact of AI, he says the underperformance of the equal-weighted S&P 500 index — which caps the influence of the so-called “Magnificent Seven” tech heavyweights — better reflects the challenging macro environment. This index is flat on the year.

Bank of America Corp. strategist Savita Subramanian also said that long-term growth expectations for the S&P 500 are near all-time lows when you exclude the group of tech giants. But, in contrast to Boivin, she said an indicator at the bank that compiles strategists’ recommended allocation to stocks is getting closer to flashing “buy.” The gauge’s current level implies a 15.5% price return for the S&P 500 over the next 12 months, Subramanian said.