Bottom or bear market? What stock-market investors need to know about stagflation and the Fed

It will take more than Friday’s big rebound to end fears of a bearish stock market, as uncertainty over the Federal Reserve’s ability to control inflation without sinking the economy fuels fears of a stalemate. pernicious combination of slow economic growth and persistent inflation.

Stagflation is “a horrible environment” for investors, which usually causes stocks and bonds to lose value simultaneously and wreak havoc with traditional portfolios divided into 60% shares and 40% bonds, Nancy said. Davis, founder of Quadratic Capital Management.

This was already the case in 2022. Bond markets have lost ground as Treasury yields, which move in the opposite direction to prices, soared in response to inflation, which has remained at its highest in more than forty years, along with expectations of an aggressive monetary tightening by the Fed. Since the record close of the S&P 500 index on January 3 this year, stocks have fallen, leaving the major-cap benchmark to formally enter bearish territory.

iShares Core US Aggregate Bond ETF AGG,
has dropped more than 10% to date until Friday. It tracks Bloomberg’s U.S. aggregate bond index, which includes Treasury bonds, corporate bonds, munitions, mortgage-backed securities and asset-backed securities. The S&P 500 SPX,
+ 2.39%
down 15.6% in the same stretch.

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

“Not only are long-term Treasury bonds and investment grade credit moving almost one by one, but sales of long-term Treasury bonds also more often coincide with the fall days of the S&P 500.” , said.

Investors seeking solace were disappointed Wednesday. The expected US consumer price index in April showed that the annual rate of inflation slowed to 8.3% from a four-decade high of 8.5% in March, but economists had been looking for a sharper slowdown and the basic reading, which eliminates food and energy price volatility, showed an unexpected monthly rise.

This underscores the fears of stagflation.

Davis is also the portfolio manager of the IVOL Quadratic Interest Rate and Exchange Rate Exchange Trading Fund.
+ 0.69%,
with about $ 1.65 billion in assets, which it intends to use as hedging against the increase in fixed income volatility. The fund has inflation-protected securities and is exposed to the differential between short- and long-term interest rates, he said.

The interest rate market is currently “very complacent,” he said in a telephone interview, indicating expectations that the Fed’s interest rate hikes “will create a disinflationary environment” when it is unlikely that the Fed will hardening do nothing to solve supply problems. which are affecting the economy in the wake of the coronavirus pandemic.

Meanwhile, analysts and traders were debating whether Friday’s stock market rebound heralded the start of a landing process or just a rebound in oversold conditions.

“After a week of strong sales, but with inflationary pressures falling just outside the margins, and the Fed seems to be still married with 50 basis point hikes for each of the next two. [rate-setting] meetings, the market was ready for the kind of strong endemic rally to withstand market uptrends, “said Quincy Krosby, chief stock strategist at LPL Financial.

It was a whole bounce. The Nasdaq Composite COMP,
+ 3.82%,
which fell in a bear market earlier this year and fell to a low of almost 2 and a half years last week, rose 3.8% on Friday to its highest one-day percentage gain since November 4, 2020. This reduced its weekly drop. up to a still strong 2.8%.

The S&P 500 rebounded 2.4%, almost halving its weekly decline. As a result, the U.S. benchmark index fell 16.1% from its record close in early January, after ending close to the 20% decline that would meet the technical definition of ‘a bear market. The Dow Jones Industrial Average DJIA,
+ 1.47%
it rose 466.36, or 1.7%, leaving it with a weekly decline of 2.1%.

Reads: Despite the rebound, the S&P 500 is dangerously close to the bear market. Here is the name that counts

And the top three indexes feature long weekly loss series, with the S&P 500 and Nasdaq each for six consecutive weeks, the longest stretch since 2011 and 2012, respectively, according to Dow Jones Market Data. The Dow recorded its seventh straight week of losses, its longest streak since 2001.

The S&P 500 is yet to formally enter a bear market, but analysts do not see a shortage of urine behavior.

As Jeff deGraaf, founder of Renaissance Macro Research, noted on Wednesday, stock correlations were running between the 90th and 100th deciles, which meant a gradual return that suggested stocks were trading highly in 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 note that large stock market crashes are normal and occur frequently, analysts said. Barron’s noted that the stock market has seen 10 declines in the bear market since 1950 and numerous other corrections and other major declines.

But it is understandable that the speed and scope of the recent rally is worrying investors, especially those who have not experienced a volatile downturn, said Randy Frederick, CEO of trading and derivatives at the Schwab Center for Financial Research, in a statement. telephone interview.

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

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

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