Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 511

Why high-flying markets are ignoring economic challenges

To make sense of today’s market conundrum, remember that things could have been worse than they are, and that investors are more defensive than they appear.

There was a question implied at the start of our last Asset Allocation Committee Outlook: How could we have called the overall challenging economic outlook, but then watched markets move in unexpected directions?

We are still asking that question deep into the second quarter, with another big bank failure under our belts and rising interest rates, yet equity markets are bouncing around seven-month highs.

What are we missing, in the economy or the structure of the market, that might explain these apparent disconnects?

Squeeze

Each time we run through all the reasons to be bearish on equities, we are struck by just how long the list is.

Monetary and credit conditions are tightening simultaneously, as both central banks and commercial banks rein themselves in. Yield curves remain steeply inverted, with high volatility at the front end.

Inflation is proving sticky everywhere, especially in Europe and the U.K., where the Bank of England faces a growing dilemma, and increasingly in Japan. Monetary policymakers who were tentative a few weeks ago, as the banking sector wobbled, have grown hawkish again. The market-implied probability of more rate hikes is rising again. Bank rescues and the Bank of Japan’s (BoJ) decision to maintain its yield-curve control provided unexpected liquidity flows earlier in the year, but the effects are beginning to fade and reverse.

At the corporate level, realized and forecast earnings are declining and inflation is beginning to squeeze margins.

Add it all up, and closely watched aggregate indicators put the probability of a U.S. recession at around 70 – 80%. And that’s without an equally long list of exogenous tail risks: trouble within commercial real estate and regional banks, disruptive global flows when the BoJ begins its expected policy normalization, and an escalation of U.S.-Russia and/or U.S.-China tensions.

Nonetheless, equity markets keep nudging higher.

Starting over

One way to make some sense of this is to remember the starting point, as well as the direction things appear to be headed.

Yes, central banks and commercial banks are withdrawing liquidity, but there was a vast amount of liquidity to begin with, and there is still plenty out there. While the consumer may be softening slightly in the face of inflation, employment is high, wages continue to rise and there is still cash in pockets—and, among the more affluent, in savings accounts. Companies are generally not over-leveraged or facing imminent refinancing pressures. And the fiscal impulse remains positive, even as the monetary impulse has turned negative.

Another thing to remember is that, while some things seem bad, they could have been even worse.

Yes, inflation is proving sticky. But imagine, for a moment, that you’d been offered all the good news associated with the reopening of China and the resilience of jobs markets at the start of the year. Might you have turned that good news down over worries that it would stoke commodity prices and inflation more than it has?

Looking at it this way reminds us that interest rates could have been far higher today than they are, and companies and consumers could have been much more sensitive to them than they have been. Where there is sensitivity—bank balance sheets, for example—central banks have shown themselves ready and willing to intervene and take out the tail risk. Perhaps investors are recognizing that the cycle may be less volatile than they feared nine months ago.

Signals

Another way to square things up is to question the signals we are taking from the markets.

It may appear that investors are strangely calm in the face of flashing red recession alarms and swirling tail risks, but appearances can be deceiving.

A month ago, I noted the contrast between low volatility in equity markets and exceptionally high volatility in fixed income. Two weeks later, Joe Amato wrote a “Tale of Two Indices,” noting how a handful of mega-cap tech stocks were making the S&P 500’s performance and valuation look much better and higher than the underlying reality. Nvidia, having more than doubled in price already this year, was up almost 25% in a single day last week, after smashing analysts’ earnings expectations.

It is an observable fact that underlying factor and sector volatility is actually very high but masked by the dominance of that handful of mega-cap tech stocks. There is a good deal more market uncertainty about the path of the economy than the index return suggests.

Why has this small group of mega-cap tech stocks broken free of the underlying uncertainty? Given the sudden flurry of excitement around advances in artificial intelligence, investors may be seeking out potential beneficiaries of this kind of transformative technological change.

But it is also possible that they have started to trade like safe-haven assets at a time when traditional havens such as U.S. Treasuries and the dollar are beset by doubt. As noted by my colleague, Raheel Siddiqui, it is not the growth or value style factors that have outperformed so far this year, but quality, low-beta and low-risk factors across every style.

Perhaps market participants are more concerned than they look, after all.

A mix of dynamics

To resolve the puzzle, recognize that the reality is likely a mix of these dynamics. The global economy could easily have been in a much worse state than it is, given the conditions it faced toward the end of last year. And investor positioning is more defensive than it appears.

With that in mind, while we may need to look again at how we think about quality and safe havens, the main pillars of our outlook remain intact. Now is not an opportune time to seek out broad equity market risk, in our view—and the market seems to agree. We don’t think long-duration assets are the place to be over the coming cycles: The more resilient the economy is to higher rates, the more likely they are to stay high. And with short-dated rates as high as they are, the opportunity cost of waiting out the uncertainty is low—even if the frustration of waiting is occasionally high.

 

Erik L. Knutzen, CFA, CAIA and Managing Director, is Co-Head of the Neuberger Berman Quantitative and Multi-Asset investment team and Multi-Asset Chief Investment Officer. Neuberger Berman is a sponsor of Firstlinks. This information discusses general market activity, industry, or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice. It is not intended to be an offer or the solicitation of an offer.

For more articles and papers from Neuberger Berman, click here.

 

banner

Most viewed in recent weeks

16 ASX stocks to buy and hold forever, updated

This time last year, I highlighted 16 ASX stocks that investors could own indefinitely. One year on, I look at whether there should be any changes to the list of stocks as well as which companies are worth buying now. 

UniSuper’s boss flags a potential correction ahead

The CIO of Australia’s fourth largest super fund by assets, John Pearce, suggests the odds favour a flat year for markets, with the possibility of a correction of 10% or more. However, he’ll use any dip as a buying opportunity.

2025-26 super thresholds – key changes and implications

The ABS recently released figures which are used to determine key superannuation rates and thresholds that will apply from 1 July 2025. This outlines the rates and thresholds that are changing and those that aren’t.  

Is Gen X ready for retirement?

With the arrival of the new year, the first members of ‘Generation X’ turned 60, marking the start of the MTV generation’s collective journey towards retirement. Are Gen Xers and our retirement system ready for the transition?

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

What Warren Buffett isn’t saying speaks volumes

Warren Buffett's annual shareholder letter has been fixture for avid investors for decades. In his latest letter, Buffett is reticent on many key topics, but his actions rather than words are sending clear signals to investors.

Latest Updates

Investing

Finding the best income-yielding assets

With fixed term deposit rates declining and bank hybrids being phased out, what are the best options for investors seeking income? This goes through the choices, and the opportunities and risks involved.

Shares

What history reveals about market corrections and crashes

The S&P 500's recent correction raises concerns about a bear market. History shows corrections are driven by high rates, unemployment, or global shocks, and that there's reason for optimism for nervous investors today. 

Shares

The ASX is full of old, stodgy, low-growth companies

Eight of the ASX's top 10 stocks are more than a hundred years old, while in the US there's just one. It points to our market being filled with low-growth dinosaurs compared to the US where innovation and renewal rule.

Retirement

Time to review the family home's exemption from Age Pension test

Improving housing mobility in Australia is crucial for enhancing both individual well-being and the economy. Potential reforms include ensuring greater rental security and incentivising downsizing among older homeowners.

Superannuation

Death benefits from super don't need to be this complicated

This may surprise you, but a person's super balance does not automatically form part of their estate. A simple change could bring greater certainty to Australians, quicker payouts for families, and lower super fees.

Economy

The RBA deserves kudos for a job well done

Over the past few years, the Reserve Bank of Australia has been subjected to a blizzard of criticism. Yet, despite its flaws, it may just have engineered that rarest of beasts: the fabled soft economic landing.

Investing

Asia deserves a closer look from investors

As part of their global exposure, Australian investors typically allocate most to Developed Markets equities, and a smaller portion to Emerging Markets. This looks at the latter position and whether there might be a better way.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.