I’m not entirely sure it’s comforting to compare February’s bout of market turmoil with the mid-cycle correction that occurred in May-June of 2006 because you know, 28 months after that episode the world ended, but while we’re looking for analogs…
And here’s the VIX during that same stretch:
As we all look forward to the latest read on inflation in the U.S. and as we ponder the future of the central bank “put” on a day when Jerome Powell made his first public comments as Fed Chair (just a week after watching the market collapse the same day he took the reins), Goldman thinks the episode shown above might shed some light on what everyone is for now assuming will be seen, in hindsight, as a mid-cycle correction that didn’t ultimately develop into a bear market that presaged a recession.
“Like now, that was a period of synchronous global growth, USD weakness, and strong equity markets – all of which were interrupted by a sharp and broad based correction across global asset markets sparked by upside inflation and downside activity surprises,” Goldman writes, before going on to note that while “no historical analogue is perfect, a surprising number of similarities exist between that episode and the present market context [as] in both cases, upside inflation surprises were part of the catalyst for the correction, and other common traits included a backdrop of synchronous global growth, solid EM fundamentals, a new Fed chair and fears of protectionism.”
Here’s a cross-asset comparison between the current episode and that which unfolded 12 years ago:
Obviously, the main difference so far is DM rates and that kinda gets at the core of the problem. But if you can get past that or, perhaps more appropriately, if you’re looking for some confirmation bias for your still-bullish take, there’s good news. That mid-cycle dip was, to quote Goldman, “ultimately a buying opportunity as inflation and growth fears calmed and the Fed turned less hawkish.” Here’s the table:
And for those interested in knowing what events conspired to catalyze the rebound, here’s a little history lesson from Goldman:
The combination of lower long-end rates, a bounce-back in the data and dovish Fed commentary all helped to stabilize the markets and renew investor confidence in the global growth and policy outlook. In particular, in mid-June 2006, positive news on the activity front (coming from the Empire State and the Philly Fed indices) reassured investors that the US economy was on a better footing than feared. On June 29, the FOMC raised rates to 5.25% in what would be the seventeenth and last hike of the 2004-2006 cycle, and struck a dovish tone that caused equities to bounce and the broad Dollar to weaken. Lastly, on July 19, the new Fed chair Ben Bernanke sparked a further rally in equities and bonds (and a USD sell-off) at his Humphrey-Hawkins testimony, after commenting that core inflation was expected to decline.
So the bottom line here would appear to be that what’s needed is “more cowbell” in terms of a dovish Fed and signs that inflation pressures are set to remain subdued enough to make any further normalization of policy some semblance of “beautiful” (to apply Ray Dalio’s sanguine take on a “deleveraging” that never actually happened).
And while Goldman thinks something akin to that is still the base case, they do warn that the “strike price of the ‘policy put’ is still some distance away.”