'Nowhere to hide?'  How stagflation fears put stocks on the brink of a bear market

‘Nowhere to hide?’ How stagflation fears put stocks on the brink of a bear market

It will take more than Friday’s big rebound to dispel fears of a bear market in equities as uncertainty over the Federal Reserve’s ability to rein in inflation without sinking the economy stokes fears of stagflation – a pernicious combination of slow economic growth and persistent inflation.

Stagflation is “a terrible environment” for investors, typically causing stocks and bonds to lose value simultaneously and upending traditional portfolios split 60% in stocks and 40% in bonds, said Nancy Davis, founder of Quadratic Capital. Management.

This has already been the case in 2022. Bond markets lost ground as Treasury yields, which move opposite to prices, soared in reaction to inflation at their highest in over forty years. and expectations of aggressive monetary tightening from the Fed. Since the record close of the S&P 500 on Jan. 3 this year, stocks have fallen, leaving the large-cap benchmark on the brink of officially entering bear territory.

The iShares Core US Aggregate Bond ETF AGG,
-0.43%
is down more than 10% year-to-date through Friday. It tracks the Bloomberg US Aggregate Bond Index, which includes treasuries, corporate bonds, munis, mortgage-backed securities and asset-backed securities. The S&P 500 SPX,
+2.39%
is down 15.6% over the same period.

The situation leaves “virtually nowhere to hide,” analysts at Montreal-based PGM Global wrote in a note last week.

“Not only are long-term Treasuries and Investment Grade credit moving almost one-for-one, but the long-term Treasury sell-offs also coincide more frequently with down days for the S&P 500,” they said. .

Investors looking for comfort were disappointed on Wednesday. The much-anticipated U.S. consumer price index for April showed the annual pace of inflation slowed to 8.3% from a more than four-decade high of 8.5% in March , but economists were looking for a deeper slowdown, and the core reading, which suppresses volatile food and energy prices, showed an unexpected monthly rise.

This underscores fears of stagflation.

And Federal Reserve Chairman Jerome Powell warned in a radio interview on Thursday that policymakers’ ability to fight inflation while avoiding a “hard landing” in the economy was uncertain.

“So whether we can execute a soft landing or not, it may actually depend on factors that we don’t control,” Powell said.

Davis is also portfolio manager of the Quadratic Interest Rate Volatility and Inflation Hedge Exchange-Traded Fund IVOL,
+0.69%,
with approximately $1.65 billion in assets, which aims to act as a hedge against rising volatility in fixed income securities. The fund holds inflation-protected securities and is exposed to the differential between short- and long-term interest rates, she said.

The rates market is currently “very complacent,” she said in a phone interview, signaling expectations that the Fed’s interest rate hikes “will create a disinflationary environment,” while the tightening is unlikely to do anything to address supply-side issues. plaguing the economy as a result of the coronavirus pandemic.

Meanwhile, analysts and traders wondered if Friday’s stock market rebound signaled the start of a bottoming process or was simply a rebound from oversold conditions. Skepticism from a bottom ran high.

“After a week of strong selling, but with inflationary pressures easing just at the margin, and the Fed still seems committed to 50 basis point hikes for each of the next two [rate-setting] meetings, the market was primed for the type of strong rally endemic to bear market rallies,” said Quincy Krosby, chief equity strategist at LPL Financial.

Mark Hubert: The beginning of the end of the stock market correction could be near

“Friday’s bounce managed to almost halve this week’s losses, but despite the massive volume to the upside, overall volume was below normal and it will take more to think that even minor lows are at hand. at your fingertips,” said Mark Newton, Head of Technical Strategy at Fundstrat.

In a chart: The stock market’s “ultimate lows” are still ahead because investors haven’t capitulated yet, says B. of A.

It was quite a twist. The Nasdaq Composite COMP,
+3.82%,
which slipped into a bear market earlier this year and fell to a nearly 2.5-year low last week, jumped 3.8% on Friday for its biggest one-day percentage gain since Nov. 4 2020. That reduced its weekly drop to a still hefty 2.8%.

The S&P 500 rose 2.4%, nearly halving its weekly decline. That left the large-cap U.S. benchmark down 16.1% from its record close in early January, after ending on Thursday just before the 20% pullback that would meet the technical definition of a market. bearish. The Dow Jones Industrial Average DJIA,
+1.47%
rose 466.36, or 1.7%, leaving it with a weekly decline of 2.1%.

Lily: Despite the rebound, the S&P 500 is hovering dangerously close to the bear market. Here’s the number that matters

And all three major indexes have long weekly losing streaks, with the S&P 500 and Nasdaq each down for six straight weeks, the longest stretch since 2011 and 2012, respectively, according to Dow Jones Market Data. The Dow Jones recorded its seventh straight losing streak – its longest streak since 2001.

The S&P 500 has yet to officially enter a bear market, but analysts see no shortage of sea urchin behavior.

As Jeff deGraaf, founder of Renaissance Macro Research, observed on Wednesday, correlations between stocks were between the 90th and 100th decile, signifying synchronized performance that suggested stocks were trading largely on the downside. unison – “one of the defining characteristics of a bear market”.

While the S&P 500 has moved “uncomfortably close” to a bear market, it’s important to keep in mind that big stock market pullbacks are normal and happen frequently, analysts said. Barron’s noted that the stock market has seen 10 bear market pullbacks since 1950, along with many other major corrections and setbacks.

But a slowdown following the speed and magnitude of the recent rally could understandably leave investors shaken, especially those who haven’t experienced a volatile downturn, said Randy Frederick, managing director of trading and derivatives at the Schwab Center. for Financial Research, in a telephone interview.

Related: Welcome to the first Gen Z bear market

The rally had seen “all sectors of the market rise”, he noted. “This is not a normal market” and now the worm has turned as monetary and fiscal policy tightens in response to runaway inflation.

The appropriate response, he said, is to follow the same tried and true but “boring” advice usually offered during volatile markets: Stay diversified, hold many asset classes, and don’t panic or make changes. massive to wallets.

“It’s not fun right now,” he said, but “that’s how real markets work.”

Leave a Comment

Your email address will not be published.