‘Nowhere to hide?’ Why stagflation fears put stocks on verge of a bear market

It will take more than Friday’s big rebound to allay fears of a bear market in equities, as uncertainty about the Federal Reserve’s ability to get a handle on inflation without sinking the economy to fuel stagflation – a pernicious combination of sluggish economic growth and persistent inflation.

Stagflation is “a terrible environment” for investors, usually leading to stocks and bonds simultaneously losing value and wreaking havoc with traditional portfolios divided 60% into stocks and 40% into bonds, said Nancy Davis, founder of Quadratic Capital. management.

That was already the case in 2022. Bond markets have lost ground as government bond yields, which are opposed to prices, rose in response to inflation that was its highest in more than 40 years, along with expectations of aggressive monetary tightening by the Fed. Since the S&P 500 index’s record high closed on January 3 this year, stocks have spiraled downward, putting the large-cap benchmark on the cusp of formally entering bear market territory.

The iShares Core US Aggregate Bond ETF AGG,
has fallen more than 10% so far through Friday. It tracks the Bloomberg US Aggregate Bond Index, which includes government bonds, corporate bonds, currencies, mortgage-backed securities, and asset-backed securities. The S&P 500 SPX,
decreased by 15.6% over the same stretch.

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

“Not only are long-term Treasuries and Investment Grade credits going close to one-to-one, but sell-offs in long-term Treasuries are also more likely to coincide with down days in the S&P 500,” they said.

Investors seeking solace on Wednesday were disappointed. April’s much-anticipated U.S. consumer price index showed the annual inflation rate slowing to 8.3%, from 8.5% in March in more than four decades, but economists had been looking for a more pronounced slowdown, and the core value, which rules out volatile food and energy prices, showed an unexpected monthly increase.

That is underlined fear of stagflation.

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

The interest rate market is currently “very complacent,” she said in a telephone interview, signaling expectations that Fed rate hikes “will create a disinflationary environment,” while tightening is unlikely to do anything to alleviate supply-side problems. to solve. plaguing the economy in the wake of the coronavirus pandemic.

Meanwhile, analysts and traders were debating whether Friday’s rally in the stock market marked the start of a bottoming process or was just a rebound from oversold conditions. The skepticism of a bottom ran high.

“After a week of heavy selling, but with inflationary pressures just waning at the margins, and the Fed still seemingly stuck on increases of 50 basis points for each of the next two [rate-setting] During the meetings, the market was primed for the kind of strong rally that is endemic to carry market rallies,” said Quincy Krosby, chief equity strategist at LPL Financial.

Mark Hulbert: The beginning of the end of the stock market correction may be near

“Friday’s upswing managed to nearly halve this week’s losses, but despite the massive volume upside, overall volume has been subpar and it will take more to think even minor lows are close,” said Mark Newton, chief technical officer. strategy at Fondsstrat.

It was quite a bouncy ball. The Nasdaq Composite COMP,
which entered a bear market earlier this year, falling to a nearly 2 1/2-year low in the past week, rose 3.8% on Friday for the largest single-day percentage increase since Nov. 4, 2020. That made up for the weekly decline off. to a still hefty 2.8%.

The S&P 500 bounced back 2.4%, cutting the weekly decline nearly in half. As a result, the US large-cap benchmark fell 16.1% from its record early January after coming just behind the 20% pullback on Thursday that would meet the technical definition of a bear market. The Dow Jones Industrial Average DJIA,
rose 466.36, or 1.7%, giving it a weekly decline of 2.1%.

Read: Despite the bounce, the S&P 500 is hovering dangerously close to a bear market. This is the number that counts

And all three major indices have long, weekly losing streaks, with the S&P 500 and Nasdaq each falling for six weeks in a row, the longest stretch since 2011 and 2012, respectively, according to Dow Jones Market Data. The Dow recorded its seventh consecutive loss week – its longest streak since 2001.

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

As Jeff deGraaf, founder of Renaissance Macro Research, noted Wednesday, correlations between stocks ran in the 90th to 100th decile, meaning lockstep performance suggested stocks were trading largely in unison — “one of the defining characteristics of a bear market.”

While the S&P 500 has come “uncomfortably close” to a bear market, it’s important to keep in mind that major stock market pullbacks are normal and common, analysts say. Barron’s noted that the stock market has seen 10 bear market pullbacks since 1950, and numerous other corrections and other significant pullbacks.

But a downturn from the speed and magnitude of the recent rally could understandably upset investors, especially those who haven’t experienced a volatile downturn, Randy Frederick, general manager of trading and derivatives at the Schwab Center for Financial Research, said in a telephone call. interview.

The rally had seen “every sector of the market rise,” he noted. “That’s not a normal market” and now the worm has turned as monetary and fiscal policies tighten in response to hot inflation.

The correct 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 wholesale changes to portfolios.

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

Leave a Comment

Your email address will not be published.