The possibility of higher-for-longer interest rates following the resilient US labour market data and the US sovereign credit rating downgrade by Fitch is not necessarily a negative for stocks. From a historical standpoint, yields start to bite on equity valuations once the 10-year Treasury yield surpasses the 5% level, which seems less plausible this time around.

Markets have in fact widely digested the higher yield environment, and an inflection point seems harder to reach. This was highlighted by the strong performance of equity indices, such as the S&P 500 (up 17.7% year to date) and the information technology heavy Nasdaq index (up 33.5% year to date), which has recouped part of the valuation loss experienced in 2022.

While it is true that equities have experienced souring sentiment last week dictated by a spike in volatility (the VIX index reached close to 17 after a low of 12 the previous week), the setback in equity markets has been mostly a profit-taking exercise for investors. There is indeed a growing conviction that the US will manage to avoid a recession and that the US Federal Reserve will be able to deliver a soft landing. We also expect an earnings recovery in the US from Q3 onwards, as the profit pain for the S&P 500 is probably over, given the easing inflationary pressures. Furthermore, as the macroeconomic backdrop continues to heal, steadily declining inflation dynamics and current upside revisions to economic growth will continue to assist solid equity returns in the coming months.

Strategic outlook

With regards to our strategic outlook, we keep a balanced approach in our sector ratings favouring quality growth names coupled with some defensive plays. We also reiterate a selective approach towards high free-cash-flow names with rewarding dividend yields and continue to favour US over European equities.