Broad equity indices set new lows in the bear market last week, shattering the notion that prices seen earlier this summer would turn out to be the lows many strategists had come to believe.
In two short weeks, investors shifted their focus from whether the mid-June to mid-August summer rally could be revived and possibly extended, to whether we are on the brink of the global recession. There is even talk of becoming a secular bear market. This is when there is a long and prolonged period of declining yields driven by trends not associated with typical business cycles.
The overall Morningstar US Market PR Index hit a new low on September 27, surpassing the previous nadir on June 16. The index was down 23.05% for the year through Wednesday and has lost around 8.53% over the past 30 days.
Bond yields hit their highest levels in years, with the 2-year Treasury note at 4.16% and the 10-year note briefly above 4% on Tuesday for the first time in 14 years, before stabilizing at 3.82%. Credit markets are reacting to the Federal Reserve’s projections that the appropriate federal funds rate will be 4.40% at year-end, one percentage point higher than expected in June. The turmoil surrounding fiscal policies in the UK under new Prime Minister Liz Truss, worries about a looming recession in Europe and slowing growth in China have also drawn foreign investors to the perceived haven of the US bond market.
5 factors leading to new lows
What changed ? You can count on one hand the reasons why the markets fell:
- A surprisingly high August consumer price index reading. The September 13 report showed that inflationary pressures were far from peaking, adding pressure on the Fed to maintain its aggressive tightening stance.
- A doozy of a warning from FedEx (FDX) September 15. The company said its fiscal 2023 first quarter would be significantly below expectations and withdrew the full-year 2023 earnings guidance it provided in late June. The global transportation and delivery company cited lower global volumes due to macro trends, particularly in Asia and Europe, which had worsened significantly by the end of the quarter. He also said he expects conditions to “weaken further” in the second quarter. Its stock plunged 21% in the following trading session.
- A more hawkish Federal Reserve board raised the federal funds rate an additional 0.75% on Sept. 21. This was the third consecutive 0.75% increase and the fifth increase this year, bringing rates to 3.00%. Chairman Jerome Powell took a tougher tone in describing the central bank’s determination to fight escalating inflation. He promised the Fed would move rates “deliberately to a level that will be tight enough” to bring inflation back to the 2% target level, reiterating past statements that it “will likely require maintaining tight policy for some time. and that it is “likely to require an extended period of below-trend growth”.
- A booming US dollar gaining strength from rising rates. The appreciation of the dollar puts pressure on corporate profits. It also drives other currencies lower, leading foreign investors to flock to the safe haven of US Treasuries, pushing yields higher and making bonds a more attractive alternative to stocks.
- A deceleration in earnings growth and lower expectations. Earnings estimates for the third and fourth quarters of this year and each of the quarters next year have been cut, according to Yardeni Research. Stock performance is closely tied to earnings growth. In addition to earnings revisions, the forward price/earnings multiple fell to 15.4 on September 26 from 16.2 on September 20. When multiples increase, it is a sign of confidence that corporate earnings and cash flow will increase and investors are willing to pay a higher price for those earnings. Conversely, when multiples contract, investors discount the deterioration in earnings and pay lower prices for those earnings.
FedEx’s warning was a jab at the front on the earnings front. Other companies, including General Electric, Alcoa, Nucor and US Steel, also recently said that rapidly deteriorating market conditions were negatively impacting earnings.
Due to changing momentum, market strategists have taken more cautious stances.
What’s next for the markets?
Ned Davis Research’s chief global investment strategist, Tim Hayes, for example, changed his recommendation to an underweight position in global equities on Monday, moving 10% to cash. The company now recommends allocating 50% to equities (5% underweight), 35% to bonds (market weight) and 15% to cash (5% overweight). Hayes called NDR’s August upgrade to a 5% overweight in global equities “premature” because the June 16 low did not hold.
He noted that clients are increasingly concerned about the possibility of a long and severe secular bear market as opposed to a short and slight bear in a secular bull market.
Richard Bernstein Advisors told clients in a note that “the likelihood of negative returns is highest in the relatively certain scenario we are considering.”
“We prefer to structure portfolios for the only two certainties we see for the next 6-12 months: the Fed will tighten and earnings will decelerate,” analysts at the firm said. “This combination of events is generally not good for equity markets, and we now have our lowest equity beta and highest cash levels in years.”
Even the most optimistic strategists admit that it will take clearer evidence that the Fed’s rate policies are working before there is a possibility that the central bank can loosen its grip on the economy, which would allow the market stock market to resume an upward trajectory.
By increasing the cost of borrowing and reducing the demand for goods and services, as well as jobs, the Fed hopes to ensure price stability throughout the economy. The risk is that the economy will be pushed into recession.
“Paradoxically, it will take weak economic indicators to rally the market,” says Ed Yardeni, president and chief investment strategist at Yardeni Research, a global investment research and advisory firm.
