By William Watts
A big bounce for stocks on Friday still leaves the main U.S. stock market benchmark close to entering a bear market as investors fret over the Federal Reserve’s ability to get a grip on inflation without sinking the economy stokes fears of stagflation — a pernicious combination of slow economic growth and persistent inflation.
And it’s not just taking a toll on stocks.
Stagflation is “an awful environment” for investors, usually resulting in stocks and bonds losing value simultaneously and playing havoc with traditional portfolios divided 60% to stocks and 40% to bonds, said Nancy Davis, founder of Quadratic Capital Management.
That’s already been the case in 2022. Bond markets have lost ground as Treasury yields, which move opposite to prices, soared in reaction to inflation running at the highest in more than forty years along with expectations for aggressive monetary tightening by the Fed. Since the S&P 500 index’s record close on Jan. 3 this year stocks have been on a slide that’s left the large-capitalization benchmark on the verge of formally entering bear market territory.
The iShares Core U.S. Aggregate Bond ETF /zigman2/quotes/200660887/composite AGG +0.04% is down more than 10% year to date through Friday. It tracks the Bloomberg U.S. Aggregate Bond Index, which includes Treasurys, corporate bonds, munis, mortgage-backed securities and asset-backed securities. The S&P 500 /zigman2/quotes/210599714/realtime SPX -2.01% is down 15.6% over the same stretch.
The situation leaves “practically nowhere to hide,” wrote analysts at Montreal-based PGM Global, in a note this past week.
“Not only are long-term Treasuries and Investment Grade credit moving nearly one-for-one, but selloffs in long-term Treasuries are also coinciding more frequently with down days in the S&P 500,” they said.
Investors looking for solace were disappointed on Wednesday. The eagerly awaited U.S. April consumer price index showed the annual pace of inflation slowed to 8.3% from a more than four decade high of 8.5% in March, but economists had been looking for a more pronounced slowing, and the core reading, which strips out volatile food and energy prices, showed an unexpected monthly uptick.
That’s underlined stagflation fears.
And Federal Reserve Chairman Jerome Powell on Thursday warned in a radio interview that the ability of policy makers to fight inflation while avoiding a “hard landing” for the economy wasn’t certain.
“So the question whether we can execute a soft landing or not, it may actually depend on factors that we don’t control,” Powell said.
Davis is also portfolio manager of the Quadratic Interest Rate Volatility and Inflation Hedge Exchange-Traded Fund /zigman2/quotes/212340916/composite IVOL -0.88% , with roughly $1.65 billion in assets, which aims to serve as a hedge against rising fixed-income volatility. The fund holds inflation-protected securities and has exposure to the differential between short- and long-term interest rates, she said.
The rates market at present is “very complacent,” she said, in a phone interview, signaling expectations that Fed interest rate hikes are “going to create a disinflationary environment,” when tightening is unlikely to do anything to resolve the supply-side problems that are plaguing the economy in the wake of the coronavirus pandemic.
Meanwhile, analysts and traders were debating whether the stock market’s Friday bounce heralded the start of a bottoming process or was merely a bounce from oversold conditions. Skepticism of a bottom ran high.
“Following a week of heavy selling, but with inflationary pressures easing just at the margin, and the Fed still seemingly wedded to 50 basis point hikes for each of the next two [rate-setting] meetings, the market was poised for the kind of strong rally endemic to bear market rallies,” said Quincy Krosby, chief equity strategist at LPL Financial.
“Friday’s bounce managed to cut this week’s losses nearly in half, but despite the massive upside volume, overall volume was sub-par and more will be needed to think even minor lows are at hand,” said Mark Newton, head of technical strategy at Fundstrat.