Thoughts on the market rout
By Julien Lafargue, Chief Market Strategist at Barclays Private Bank
Please note: The article does not constitute advice or any form of investment recommendation. All numbers quoted were sourced from Bloomberg data as at Friday 23 September. Past performance is never a guarantee of future performance.
The rout across global markets last week dramatically revealed underlying investor unease that had been building throughout an already-bumpy year. It also hammered home the reality of 2022 for investors – having started the year with expectations of sustained economic growth, they’re instead facing recession concerns and aggressive monetary policy.
In a sign of how quickly the mood has changed, you only have to look back to this time last year. In September 2021, the Federal Open Market Committee (FOMC) was pencilling in one 25bp hike in 2022. Fast forward to today, and if we’re to believe the US Federal Reserve’s current projections, then it is not inconceivable that the central bank will have delivered more than 17 hikes by the end of this year (assuming one hike = 25 basis points).
The scale of these rate hikes is unprecedented, and given America’s status as the world’s most influential economy, they have wide-ranging implications.
There are clearly significant differences between a world where US rates are at 0.25%, and one where they approach (or even surpass) 4%. Here are three such differences on our radar at the moment:
1. TINA out, TARA in
Given today’s macroeconomic conditions, the acronym of TINA – There is No Alternative – has in our view been replaced by TARA – There are Reasonable Alternatives.
Investors might find value in locking in rates at current levels, as fixed income markets regain their appeal. Aside from rising bond yields, it looks as though equity market valuations have no choice but to come down as (real) rates increase in an effort to cool inflation.
2. Restrictive monetary policy
A smaller version of the Fed’s interest rate pivot was expected as post-lockdown economic conditions further entrenched themselves. But the aggressive stance unfolding, in response to being sluggish earlier this year, has spooked markets.
Three months ago, the Fed fund futures curve for 2023 was fairly flat, with rates topping at 3.5%. In other words, after a last hike in December, the central bank was pretty much done and the central bank would start cutting rates towards the middle of 2023. This was the “dovish pivot”.
Today, however, the same curve shows a peak at almost 4.7% in the middle of 2023 and a very tentative cut at the back end of that year. This is a “hawkish pivot” that very few saw coming.
At these levels, interest rates would certainly surpass the US long-term growth potential and therefore result in a significant slowdown of the domestic economy.
3. There is no put
Although this is not a direct function of the move higher in rates, it goes back to the reason why rates have jumped so much: the Fed’s determination to tackle inflation.
For as long as the Fed kept in mind its dual mandate – economic/job growth and price stability – the market believed that the central bank’s “put”, was still alive and that the FOMC would bail-out the economy (and markets) at the first sign of weakness.
However, with its “hawkish pivot”, the central bank has now decided that it operates in a single mandate framework and that price stability is its only priority (probably in recognition of the fact that you can’t fight inflation without hurting the economy). You can read about that in our recent article, 'US Federal Reserve tries to assert itself'.
This means that there is no buyer of last resort anymore – even governments can’t help, as shown by the reactions to last week’s mini-budget in the UK – and that markets need to find a new equilibrium.
What does it mean for investors?
The sharp, more aggressive, shift in monetary policy has totally changed the rules of the game and investors can’t help but feel lost. The world is too uncertain and price moves too violent for anyone to express a strong, short-term conviction. Few investors would take the risk of catching a falling knife.
That said, we can make a few observations. First, every time we (and the market) thought the Fed couldn’t get more aggressive, it proved us wrong. It means that investors are now just going with the flow, pricing in what the “dot plot” (ie: Fed policymakers’ short-term projection of interest rates) suggests. Unfortunately, the dot plot has a poor record of indicating what comes next, as shown by the dot plot’s dramatic shift upwards in the last three months.
Second, sentiment is extremely gloomy already, and prices are oversold. This does not necessarily mean that markets are due to pick up and rally, but it does, arguably, suggest that things could calm down a little.
Third, a lot has happened in the first nine months of this year and, most likely, a lot more will happen over the next nine months. Things may get worse, or they may get better, but one thing is certain - they won’t stay the same. This is why one shouldn’t extrapolate today’s environment, nor expect it to persist in the future and base investment decisions on it.
In this context, we believe that investors would do well to go back to basics and ask themselves some simple questions:
- Why am I investing, what are my goals, and what’s my time horizon?
- Am I taking too much risk compared to what I can tolerate?
- Is my portfolio positioned so that it can achieve my goals without taking more risk than I can support or tolerate?
There is little to gain and potentially a lot to lose trying to be a hero at the moment. Relying on proper asset allocation and the appropriate diversification would go a long way to making sure that today’s market action is just a short-term jolt across a more rewarding, longer-term investment journey.
It’s also important to remember that since 1980, the S&P 500 has produced total returns of more than 10,000% (or around 11.5% annualised), and this despite having experienced multiple double-digit drawdowns. This clearly won’t determine the future but it provides useful food-for-thought nonetheless.
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