In “‘Where Does One Go When Everything Sells Off?’” I said there’s nothing singularly terrible about a 15% drawdown.
I was referring to US equities, and specifically the S&P, which marked an inauspicious start to a potentially pivotal week. By Monday afternoon, Wall Street was mired in another unfortunate session.
At the benchmark level, the drawdown hasn’t set any records. Not even close. This isn’t, believe it or not, a particularly acute selloff. Not yet anyway.
As noted here over the weekend, out of 19 bear markets going back nearly a century and a half, the average drawdown was more than 37%. And when considered against the monumental gains logged in the aftermath of the pandemic, recent losses appear trivial.
Note that we’re nowhere near the kind of crash Jeremy Grantham predicted in January, for example. Anyone who tells you Grantham is vindicated isn’t being honest with you (figure below).
All of that said, the situation is immeasurably more perilous than it was just a few months ago. I’ve sought to make that abundantly clear across dozens of articles.
Monday’s steep losses for equities were another reminder. The fact that long-end bonds were almost no help underscored the “diversification desperation” dynamic and, more importantly, the stagflation concerns that gave rise to it. Although yields were richer at the front-end as some rate hike premium came out of swaps, there was little movement at the very long-end. 30-year yields ended lower by a few basis points and 10s by seven, but it felt reluctant. It took a final leg lower in risk assets to push the long-end richer on the day.
Although bull steepening ostensibly represents the market expressing doubts about central banks’ capacity (or willingness) to tighten aggressively into a burgeoning slowdown, the lack of a convincing rally in longer-dated bonds in the face of big losses for stocks and the generalized risk-off tone, is suboptimal. Looming supply is a factor, but the bottom line is that not much is working on a consistent basis, and the short-end could well selloff anew once markets get a look at CPI and PPI due later this week. It’s worth noting that Treasurys rallied across the curve as Asian trading got underway Tuesday.
One thing is certain: Additional upward pressure on reals as breakevens retreat (alongside crude, by the way) will continue to be highly oppressive for equities, and especially for tech.
If Monday’s losses were to hold for the rest of the week, it would mark the fifth week in six that the Nasdaq 100 has fallen 3% or more (figure above).
“Both equities and credit have already shown a sensitivity to 10-year real rates approaching +25bps,” BMO’s Ian Lyngen and Ben Jeffery said. “In late 2018, a bear market in the S&P 500 was enough for the Fed to call off tightening after delivering the final quarter-point hike of that cycle [but] that was in an environment with core and headline CPI at 2.2% and 1.9% YoY, respectively.”
Note that the ongoing selloff in big-tech (which, again, is predicated on surging real yields) is the most acute since the financial crisis if you don’t count the pandemic plunge (figure below).
The headlines weren’t generous. “Pandemic-Era Darlings Morph Into Symbols of New Market Wreckage,” one particularly caustic Bloomberg article declared, on the way to documenting a “sea of red” for recent IPOs, profitless tech, Bitcoin and, of course, Cathie Wood, whose flagship fund fell another 9% (“transformation” was “trashed,” as the linked piece put it).
As detailed here over the weekend, it’s not just that the vaunted “Fed put” is struck far lower due to the necessity of prioritizing the inflation fight. The Fed isn’t just reluctant to support equities. They’re arguably averse to seeing stocks rise if higher stocks means easier financial conditions. So, there’s a sense in which being bullish is now tantamount to fighting the Fed, a complete reversal of the dynamic investors have enjoyed over more than a decade.
If you’re wondering whether financial conditions are anywhere near tight enough to satisfy a Fed keen to curb the hottest inflation in 40 years, the answer is almost surely “no.”
“At the index level, the S&P has been impressively resilient [but] investors aren’t being rewarded for the risk the environment entails with open ended tightening,” JonesTrading’s Mike O’Rourke remarked, adding that although Goldman’s financial conditions gauge has tightened from record-easy levels, it’s “only returned to levels on par with the year 2000, when that equity bubble peaked.”
