2023-07-12 13:13:38 ET
Summary
- iShares Core Growth Allocation ETF ultimately has a lot of exposure to correlated monetary policies in the West that are all leaning hawkish.
- U.S. market returns have been driven almost exclusively by AI and the biggest of tech stocks which are exposed to hawkish policies.
- While inflation data will show abating figures, jobs data was strong and inflation not only has to come down but it has to do so quickly for Fed satisfaction.
- Markets may initially be happy about inflation figures, but unless they come very near policy levels, the labor market situation is likely to lead to more hawkishness.
- Meanwhile, the cracks are starting to show in credit conditions, but there may be a window for a soft landing.
The iShares Core Growth Allocation ETF ( AOR ) is ultimately pretty levered to the monetary policy decisions of Western nations, whose monetary policies are all pretty correlated since they've joined together in sanctions against Russia. The situation now is that the jobs data is becoming the most important metric, but markets are still wanting to see if maybe inflation is coming down close enough to policy levels where further monetary tightening will no longer be as much of a concern. While markets are expecting abating figures, it is likely that the Fed will have to stay pretty hawkish. What's more is that we're not sure whether bond markets are correctly pricing long-term rates, and only time will tell if stocks with long horizon values are overpriced on that basis.
AOR Breakdown
The AOR breakdown shows that there is meaningful exposure to equities in developed markets and to the U.S. bond market on aggregate. This means that there is negative exposure to higher rates both in the fixed income and the equity exposures.
The developed market exposures are substantially EU discretionary and industrial exposures which are going to be affected by long-term rate assumptions by the market due to their discretionary and more cyclical nature. The healthcare exposures have a little more issues from the cost of capital side, as their resilient nature means more of their values are deferred into the horizon, which is going to be more affected by long-term rate assumptions, which move with much less sensitivity to the current Fed hiking regime, but are still connected. The U.S. exposures feature a lot of tech, and this has driven the majority of the U.S. market rally of late, about two-thirds. Tech, similar to healthcare, is exposed in that horizon values which are sensitive to cost of capital assumptions drive tech valuations. Signs of structural inflation are a concern here.
The bond market has duration risk, and is exposed primarily to the shorter-term expectations for rates.
Bottom Line
At any rate, markets are going to be watching inflation figures, but they are mainly hoping to see major convergence to policy levels. The more relevant market indicator of late is the job market, because lower labor participation and tight labor conditions are making the job market belligerent to rising rates, and this is an area from which structural and perpetuating inflation can emerge. While U.S. inflation is expected to fall, and there has been abating inflation across the world as tough comps have been lapped, there is still the issue that some European nations are seeing core inflation reacceleration , and this likely stems from a tighter job market , and also service industry actors now joining the fray and other economic agents all making their moves to claim more income and increase prices for their goods and services. It could take a while before everyone has made their price hike move, and by the time they've finished that, there could be a new wave starting from those with the most pricing power. This is the concern of perpetuating inflation.
The risk of perpetuating inflation rises as endogenous effects become the source of inflation. The Fed will likely disappoint market actors who are getting excited about seeing abating inflation figures with more hawkish policy for a while longer than expected. While abating inflation in the incoming CPI report is a good thing for the U.S. market, as it relieves concerns about structural and current inflation that affect major market drivers in tech, the Fed needs inflation to fall very quickly, and is likely going to overshoot with policy to do that, despite cracks showing in the credit system already from the bank failures and now greater loan losses and credit card delinquencies. The house view is now that the Fed is going to overshoot with policy and that the economy in the U.S. is going to suffer, as are the markets, and that a soft landing is actually not too likely with issues stemming on the corporate side, even if they only come into play next year.
We've never liked iShares Core Growth Allocation ETF and its similar ETFs due to higher expense ratios than some of the original parts, where its ETF of ETFs approach seems redundant. But in this case, our greater concern is simply with the state of the markets and the potential for continued rate pressure on the indices that drive AOR. Best to pass.
For further details see:
AOR: Fed Is Still Hawkish