Goldman knows just what the market needs to hear in order to rebound sustainably. Spoiler alert: It’s an incrementally less hawkish Fed, if not an outright dovish pivot.
“A trough in activity or a shift to easier Fed policy has been necessary to bring a sustained trough to equities after large drawdowns,” the bank’s Vickie Chang said, noting that when Fed tightening is the source of market angst, policy pivots matter most.
It’s very likely that the S&P will close in a bear market at some point this week or next, despite narrowly dodging the dubious milestone so far. But that’s all semantics, and Goldman used a 15% threshold to examine peak-to-trough corrections going back to 1950.
There were 17 such episodes not including this year’s rout. Chang attempted to ascribe causation on the way to categorizing them by source (table below).
In each one of those episodes, ISM had to trough, the Fed had to ease or both, before stocks could sustain a recovery.
The takeaway is straightforward: In corrections attributed to monetary tightening (the most common cause), monetary easing is the best medicine. Whether activity rebounds is a secondary concern. “On average, monetary-policy-driven equity corrections have bottomed when the Fed has shifted towards easing, regardless of whether activity has troughed,” Chang wrote. Indeed, Goldman’s analysis suggested activity continues to struggle for several months (on average) following market bottoms in monetary-policy-induced corrections.
“In essence, when the source of the correction is known to be monetary tightening, a shift to monetary easing has provided fairly immediate relief as the market anticipates and trusts that the activity pickup will happen down the line,” Chang went on to say.
If, on the other hand, the cause of the correction isn’t known to be policy tightening, markets tend to wait for evidence of a growth trough before inflecting sustainably. In such cases, Chang remarked, “the market does not think that monetary easing is necessarily sufficient given the source of the pressures.”
Of course, the situation in 2022 is a bit of a different animal. Monetary tightening is unquestionably the cause of the correction so far (as proxied by the surge in real rates, illustrated in the familiar figure below), but the goal of policy is to engineer a slowdown. Some analysts have argued that the Fed actually wants to create a deleveraging event, on the assumption that any collateral damage and associated spillover would be worth the risk if it means slaying the inflation dragon.
Notwithstanding the (very plausible) notion that investors could soon find themselves staring down a bear market that has traits of both a policy-induced correction and a deleveraging event, the most convenient assumption is that stocks will turn when the Fed pivots.
“Using history as a guide, in order for equities to come off their recent lows (and stop declining), this kind of monetary-tightening induced contraction is most likely to end when the Fed itself shifts,” Chang wrote. “So it may be necessary for the market to become more confident than it is that financial conditions tightening has been sufficient and that the Fed has delivered and signaled enough tightening.”
That doesn’t mean the Fed needs to shift to overt easing. The Fed didn’t cut rates in January of 2019, after all. It just means markets need to believe that most of the tightening impulse is in the price.
On Monday, during remarks to reporters following an address to the Rotary Club of Atlanta, Raphael Bostic said that while both 25bps and 50bps hikes will probably be on the table for the September meeting, it’s also possible the Fed could “pause” to assess the impact of what, by then, is expected to be 175bps of rate hikes in a very compressed time frame.
“I have a baseline view where I think a pause in September might make sense,” Bostic said. “After we get through the summer… a lot will depend on the on-the-ground dynamics that we are starting to see. My motto is observe and adapt.”
Finally, I’d note that Goldman’s analysis included the observation that, “Earlier corrections from 1950 through 1990 were more often brought on by tightening monetary policy and oil shocks, while the largest corrections since then have been brought on by retrenchment in the private sector after buildups of leverage.”
I’d pose a question: What, exactly, encouraged and facilitated those “buildups of leverage”?
I’d pose a question: What, exactly, encouraged and facilitated those “buildups of leverage”?
The GOP unrelenting opposition to raising taxes on the wealthier segment of the population… thus forcing the Fed to do everything.
Makes sense. Bear markets are declines in financial assets, those are bought with money, the Fed controls the money supply, so naturally bear markets don’t end until the Fed takes its foot off the brake – or takes its pillow off the face, depending on how dire one feels about one’s portfolio. As for when the Fed does so, the table in H’s post shows the association of bear markets with recessions, so it is probable that eventually the Fed will have one of those to react to. Unfortunately for the market, this time around the Fed arguably wants a bear market, and we’ll likely have to get some way into a recession before the employment market reaches a point that will compel the Fed to lift.
No reaction to Bostic’s floating of a “September pause”. As the most dovish governor, he’s not driving the bus, and who listens to the little kid in the back row. Eventually he (in the movies, its always a he – think Sean Astin in The Goonies) gets to say “I told you so” and I wonder if Bostic isn’t trying to set himself up for that moment.