As the Federal Reserve stepped up monetary policy tightening to rein in the worst inflation in decades, U.S. Treasury yields hit their highest levels in more than a decade and stocks reversed a summer rally to dive into new depths.
The S&P 500 is down nearly 25% since the start of the year, while yields on the benchmark 10-year Treasury bond, which move inversely to bond prices, recently hit their all-time high. level since 2008.
Outside the US, the soaring dollar has led to sharp declines in global currencies, pushing Japan to support the yen for the first time in years. A slump in UK government bond prices forced the Bank of England to make temporary purchases of long-luck gilts.
Many investors are looking to the next three months with trepidation, betting that the decline in US equities will continue until there are signs that the Fed is winning its battle against inflation.
Still, the last quarter of the year has often been a good time for US equities, raising hopes that markets may have already seen the worst of the selloff.
PASS THE DIP
The strategy of buying market lows has yielded rich rewards for investors in the past, but failed in 2022: the S&P 500 has rallied 6% or more four times this year and then hit a new low each time.
In the third quarter, the index rose nearly 14% before reversing to a two-year low in September after investors recalibrated their expectations of even more aggressive Fed tightening.
BEWARE BELOW?
Several major Wall Street banks expect the benchmark to end the year below current levels – Bank of America and Goldman Sachs recently released year-end targets of 3,600 – the outlook for buy downside remain gloomy.
Furthermore, the current bear market, which has lasted 269 days so far and recorded a decline of around 25% from peak to trough, is still relatively short and shallow compared to past declines. Since 1950, the average bear market has lasted 391 days with an average decline of 35.6% from peak to trough, according to Yardeni Research.
SEE BONDS
Although equities have been volatile, bond market swings have been comparatively worse.
The ICE BofAML US Bond Market Option Volatility Estimate Index hit its highest level since March 2020, while the ICE BofA US Treasury Index is on course for its biggest annual drop ever.
By comparison, the Cboe Volatility Index – Wall Street’s so-called “fear gauge” – failed to hit its March peak.
Some investors believe the market turmoil will continue until bond markets calm down.
“I think there’s a good scenario where, once we get over the violence in the bond market, we get to a more tradable floor (for equities),” said Michael Purves, managing director of Tallbacken Capital Advisors New York. .
AND THE DOLLAR
Soaring US interest rates, the relative robustness of the US economy and investors’ search for safe havens in a context of increased financial market volatility boosted the US dollar to the detriment of other global currencies.
The greenback is up about 7% for the quarter against a basket of currencies and is near its highest level since May 2002. Dollar strength prompted the Bank of Japan to support the yen through its interventions, while constituting an obstacle to the profits of American companies.
“Market risk takers are grappling with the twin threats of continued dollar strength and dramatically rising interest rates,” Jack Ablin, chief investment officer at Cresset Capital, said in a note.
BENEFITS TEST
Third-quarter earnings could be another hurdle for markets as companies need to consider everything from dollar headwinds to supply chain issues.
Analysts have become more pessimistic about third-quarter earnings growth, with consensus estimates falling to 4.6% from 7.2% in early August, according to Refinitiv IBES. So far, that’s only marginally worse than the median drop of 2.2 percentage points before historic reporting periods, but warnings from companies such as FedEX and Ford have hinted at the possibility of more pain to come. .
IT’S THE SEASON
The calendar may offer weary stock investors some hope.
The fourth quarter is historically the best period for returns for major US equity indices, with the S&P 500 recording an average gain of 4.2% since 1949, according to the Stock Trader’s Almanac.