Trader Playbook After Fed Hike Spans Bonds, Defensive Stocks

(Bloomberg) — The market rally evaporated quickly after the Federal Reserve’s biggest rate increase since 1994, sending investors scrambling to find alternative assets.

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Now traders are turning to dividend-paying stocks, longer-dated government debt and high-quality credit as broader equity markets lose their appeal after the Fed stepped up its inflation fight with a 75-basis point rate hike.

With market players now shifting gears and hunting for returns and safe havens, HSBC is keen on commodity stocks, while UBS Global Wealth Management recommends quality income and health-care stocks as defensive strategies. Abrdn is eyeing long-end Treasuries and local emerging market rates. Some say that Chinese equities continue to offer potential gains thanks to policy support from the central bank, while others caution against further downside risks.

Here are some comments on what’s next for markets after the Fed decision:

Get Defensive

“To mitigate large potential swings in the VIX, investors can focus on more defensive parts of the market and could outperform in the event of recession,” said Mark Haefele, chief investment officer at UBS Global Wealth Management. “We particularly like quality income, dividend-paying stocks and the health care sector.”

“An environment of rising interest rate expectations and high inflation is favorable for value sectors relative to growth sectors. We favor the energy sector and the UK market, which is heavily weighted to value stocks. We hold a least preferred view on growth and on the consumer discretionary sector.”

Less Glamor

“With 8% inflation not much is attractive on a real basis,” said James Athey, investment director at abrdn. “Cash buys you optionality. On a medium-term basis, I think there is decent value in long-end Treasuries and in local emerging market rates. These are the central banks who have truly grasped the nettle on inflation and as such further upside inflation surprises would simply necessitate more aggressive monetary policy responses, which will further depress future growth outcomes – that will be supportive for rates at the long end.”

“Within equities there are areas which are more attractive on a relative basis – essentially less glamorous companies / sectors with strong balance sheets, reliable earnings and more reasonable looking valuations.”

Oil Proxies

“What’s worked well so far this year has been commodities, in particular energy; in equities – at least from a relative perspective – value versus growth. These still make sense to us,” said Max Kettner, chief multi-asset strategist at HSBC. “Supply in energy / oil markets is still extremely tight and consumer spending is still robust so evidently we haven’t reached the ‘pain point’ of demand destruction just yet. This means some commodity and oil proxies are also still attractive.”

Avoid US Stocks

“We look for inexpensive equities with good exposure to an inflationary growth environment (UK equities, EM equities, big health care companies) along with some very beaten-up growth businesses (green technologies/health care innovations) which are structurally cheap,” said Ben Kumar, senior investment strategist at Seven Investment Management LLP.

“We avoid US equities, which are still expensive – we prefer put selling on the S&P 500. At the same time, to protect portfolios against the risk of recession, we believe that government bonds now look acceptable once more.”

Strong Credit

“The decision does not alter the short-to-medium-term view, but some long-term opportunities will likely start to emerge in stronger credits,” said Esty Dwek, chief investment officer at Flowbank SA. “We believe that sentiment will remain fragile as few events are upcoming to act as positive catalysts, but remain more constructive for the latter part of the year.”

“Given the moves we have seen already, the decision shouldn’t impact spreads much more as the hike was not more hawkish than before — if anything a tad on the dovish side.”

Duration Exposure

“Amid the repricing in bond markets and the growing chance of a material slowing in economic activity, investors should actively consider their duration exposure and whether to start adding higher-quality intermediate-to-longer-dated government bonds to hedge against further downside risks, said Kerry Craig, global market strategist at JPMorgan Asset Management.

“In the emerging world, we see growing opportunities in China and the Asian region. The re-opening, albeit slowly, of the Chinese economy along with fiscal and monetary policy support at very low equity multiples bodes well for longer-term investors.”

“Improving domestic demand in broader Asian markets may not be fully captured in the current earnings expectations, suggesting room for upside surprise once risk appetite returns.”

Still Bumpy Ride

“The Federal Reserve pretty much delivered the hike as expected in the market,” Tim Moe, chief Asia-Pacific equity strategist at Goldman Sachs, told Bloomberg Television. The narrative remains consistent though that the next few months may be bumpy with the exception of China.

“But on the 12-month view, we think we can deliver low-teen type of upside and we think that still looks compelling for investors in navigating what obviously still looks challenging and bumpy path for markets.”

“Stronger dollar clearly is a headwind in the near term, but on the longer run, we think that the current valuation and the underlying growth will be supportive of Asian markets in the longer-term view.”

China Equities

“With inflation still the top priority for the Federal Open Market Committee, traders and investors can therefore expect to see a flush lower in equities,” said Giles Coghlan, chief analyst at HYCM Capital Markets Group, adding that Chinese stocks look attractive as the economy shows signs of picking up.

“We think there is still very much a lot of risk in the air given the next two inflationary monthly reads might disillusion and we think food price and oil inflation will likely continue to rise and hit new highs in a few months time,” said Jessica Amir, market strategist at Saxo Capital Markets. “Chinese stocks could be looked at as another way to get upside, given their central bank has been supportive.”

Weak Yen

“The difference between US interest rates and Japan’s interest rates will likely widen more, causing the weak yen environment to continue,” said Kazuma Ogino, a senior credit analyst at Nomura Securities Co. “As long as the Fed continues with 75 or 50 basis points rate hikes, the weak yen environment is inevitable.”

“A silver lining would be a recovery in the Chinese economy expected towards the end of the year, which may offset the impact somewhat. Credit investors will probably stay risk averse, investing in Japanese government bonds and avoid corporate bonds, especially ones with tenors longer than 10 years.”

(Adds comments from UBS GWM, abrdn and HSBC)

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