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‘Nowhere to hide?’ Why 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 wreak havoc with 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 indices on Jan. 3 this year, stocks have fallen, leaving the large-cap benchmark on the verge of officially entering bear territory.

The iShares Core US Aggregate Bond ETF AGG,
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,
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 in nearly the same proportion, but the selloffs in long-term Treasuries 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 underscored fears of stagflation.

Davis is also portfolio manager of the Quadratic Interest Rate Volatility and Inflation Hedge Exchange-Traded Fund IVOL,
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 telephone interview, signaling expectations that Fed interest rate hikes will create a disinflationary environment, when it is unlikely that the tightening will do anything to solve the supply problems plaguing the market. 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 massive 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 kind 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 rebound managed to nearly halve this week’s losses, but despite the massive volume to the upside, overall volume was below average and it will take more to think that even minor lows are within reach. hand,” said Mark Newton, head of technical strategy at Fundstrat.

It was quite a twist. The Nasdaq Composite COMP,
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 rebounded 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,
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, meaning consistent performance that suggested stocks were trading largely in unison, one of the defining characteristics of a bear market.

As the S&P 500 edged uncomfortably closer to a bear market, it’s important to keep in mind that big stock market pullbacks are normal and happen frequently, analysts said. Barrons noted that the stock market has seen 10 bear market pullbacks since 1950, along with numerous other major corrections and setbacks.

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

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 high inflation.

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

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




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